COVERED CALLS

Covered Calls
Also known as a covered write. In the stock market the word write means to sell. Covered meaning you own what it is that you are trying to sell.
A stock/option strategy in which stock is purchased and a call option is sold against the stock you now own. This is a low risk/low profit strategy similar to selling out-of-the-money puts. This position is called a covered write since the short call is "covered" by owning the underlying stock. The short-term risk profile of this strategy is very similar to selling an uncovered put.
There are 2 risks involved in this type of trade. The first is that the stock you purchased could go to zero. So it is always a good idea to only buy quality stocks for this type of trade. Many traders will buy a stock for a covered call because it pays great premiums but the stock is not one that has good fundamentals and technicals. Remember the first part of placing a covered call trade is actually owning the stock. Make sure it is a good one that you would not mind owning.
The second risk is that you give up the potential profits f the stock moves up drastically. Before selling a call against stock you own, you should be willing to have your stock called away from you. This strategy can be used as a way to generate monthly income or just to add value to your portfolio. Some covered call writers use this strategy as a way of selling stock that they currently own or to capture income as their portfolio drops in value.

Suppose you own MU at 38.90 and you think it is going to drop in the next month or two. You like the stock and want to own it for the long run so you do not want to sell it. If you think the stock may drop to support at 35.00 in the next few weeks and don’t want to see your portfolio drop too much you may want to sell a call against your position in MU. If you own 300 shares you can sell the Aug 45.00 calls for 0.80. If you’re a bit of a risk taker then you can sell the Aug 42.50 calls for 1.50. If MU does drop and at expiration Friday the stock is trading at support of 35.00, you will have gained 0.80 per share as the stock went down.
MU $38.90

Strike Price Call Options Last Trade Bid Ask O.I.

01 Aug 35.00 (MU HG) 0 5.60 0 41

01 Aug 37.50 (MU HT) 5.10 4.00 50 1194

01 Aug 40.00 (MU HH) 4.40 2.80 0 1485

01 Aug 42.50 (MU HV) 1.85 1.75 5 2499

01 Aug 45.00 (MU HI) 1.90 1.05 0 2512

This may not seem like much but done month after month it can start to add up. The option buyer of your call you sold has the right to buy your 300 shares of MU at 45.00 per share. If MU is currently trading at 35.00 the option buyer will most likely let his option expire. You do nothing. On Monday morning you still own your 300 shares and own the 0.80 or 1.50 per share premium you received depending on which strike price you sold.
If you are bearish on the stock you may have even sold the Aug 37.50 call for 3.70 instead of the Aug 45’s. Depending on how bullish or bearish you are will tell you which strike price to sell. If on Expiration Friday MU is trading at 38.90 and you do not want to get called out of your position, you can always place a trade to buy back the Aug 37.50 calls you originally sold. At this point the option should be trading for the intrinsic value and you can buy the option back for 1.40, you sold it for 3.70 so you make an additional 2.30 per share as the stock goes sideways.
The initial margin for a covered write is the same as for long stock. The proceeds from the call sale may be used to offset the stock purchase. The proceeds from the sell of the call option you sold are available for you to withdraw from account the next trading day if you wish to remove them for personal use. Covered call writing is something that is often done in an IRA as many investors already have stock just sitting around waiting for some types of profits.