Personal Investor: Generate income by writing covered call options
The options market can be intimidating to the average investor but in these days of rock-bottom yields, one specific type of options trade can provide much needed income from lifeless stocks.
It’s referred to as covered call writing. It’s covered because the stock is already owned by the investor. It’s a call because the investor writing it gives the buyer the right, but not the obligation, to buy it at a specified price within a specific time period. If you are writing a covered call you are selling that option to the market.
Think of it as renting out a security for a premium – with a twist. If the value of that security rises to a predetermined level – called a strike price – the renter has the right to buy it at that predetermined level.
As an example, suppose your stock is trading at $25 when you sell your covered call and the strike price is $26. If the price stays below $26 for a predetermined time period you keep the stock, the premium and any dividends the security might generate.
If it rises above $26, the buyer has the right to purchase it at $26. Either way the seller gets the premium and the dividend.
It’s not easy to determine which stocks work best for covered call writing and the market sets the premium price, so it’s best to work with an advisor to determine if the reward is worth the risk.