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Editor's Note: The covered call is one of many strategies options traders use to maximize profits. Tom broke this popular strategy down for readers back in 2015 – and because a thorough understanding of options vocabulary and strategies is so critical to success, we're sharing it with you again today. Here's Tom…
Buy-and-hold investors often watch volatility eat away at stock gains.
But there's a simple way to boost your return on investment while you hold shares for their long-term price appreciation and dividends.
One of my favorite strategies is to use leverage to get the absolute maximum profit performance from my shares each and every month.
Now, for the greatest profits and the least risk, it's critical you understand exactly how to use this strategy and when.
That's what I'm going to show you today…
Introducing… the "Covered Call"
One of the reasons I love options is that you can use them to accomplish nearly any financial goal.
With this options strategy, you actually own the shares, and you're selling the right to buy those shares on or before a specific date.
To execute a covered call, one first has to own stock or buy stock – which then may or may not be bought from you. I'll get into that in just a moment.
Consider this easy example…
Let's say you sold an XYZ Corp. Feb. 16, 2018, $50 call against a block of 100 XYZ Corp. shares that you own.
Now, let's say the market pushes that stock price to $57.
Someone out there may think it is better value for them to exercise their option and buy your stock at $50 instead of $57 per share – even if they paid a $2 premium for the right to do so – and they have until Feb. 16 to do it.
Of course, their $52 cost (that is, $50 for the stock and $2 for the option) is better than the $57 market price of the stock, so they make a profit.
But if you are not called out before the contract expires on Feb. 16, you get to keep the $2 premium you picked up when you sold the option. So, by our example here, you would keep $2 for every 100 shares, giving you a profit of $200.
For you, that's the best-case scenario because you get to keep that premium… plus your stock.
And you can look out at the next month (or even further) and decide whether you want to put the stock up for sale and get paid to do it – all over again.
This strategy can be expensive, but the expense comes from owning at least 100 shares of a stock.
One of the most important considerations about this strategy is if you're willing to sell the stock if you get called out. If you can't bear to part with the stock, don't write covered calls on it.
But if you already own stock and you don't mind if it gets bought from you, then this can be a great way to generate some additional income each month.
Now let's look at a real trade from July 2015 – one that paid off nicely for Power Profit Trades readers.
About the Author
Tom Gentile is one of the world's foremost authorities on stock, futures and options trading.
With more than 25 years' experience trading stocks, futures, and options, Tom's style of trading systems and strategies are designed to help individual investors propel themselves past 99 percent of the trading crowd.