Writing Covered Call
you like to reduce the risk of trading stocks and increase
the odds of a solid return on your holdings?
What if you could effectively buy stocks below their
What if you could reduce the size of the loss you have
on a losing position and increase the gain you have on a winning
All these goals can be accomplished using the same
conservative strategy that many have used for years: writing
covered call options against a long stock position they hold.
The strategy is called covered call writing because
you already own the stock that you might have to deliver if
the buyer of the option decides to exercise the option.
If you didnít already own the stock it would be referred
to as naked call writing,
i.e. you would have to go into the market and buy the
stock at the prevailing market price to deliver the shares
if the option was exercised by the buyer of the option.
Naked call writing is considered very speculative and
brokerage companies require significant margin positions to
engage in naked call writing.
Letís look at a couple examples of covered call writing
and how they could contribute to your bottom line.
If you purchased 100 shares of IBM at $100 you cost
If at the same time you wrote a call option with a
$115 strike price and an expiration date 60 days out, you
would received the $265 premium credited to your account.
So effectively you purchased your shares at 97 3/8
instead of $100.
Now it would make no sense for the purchaser of the
call option contract to exercise their right to buy the shares
from you for $115 a share unless they cost more than $115
in the open market.
So, if the price of IBM stays below $115 during the
life of the option, you simply get to keep the $265 premium.
If the option expires and youíre holding your shares
long term, you may even want to write a new option against
the shares youíre holding and collect the premium from the
Now if the share price of IBM rises above the strike
price, say to $120 your shares may or may not be called away
Letís look at a couple scenarios.
The holder of the option may decide to exercise the
option, in which case you have two methods to unwind your
You could deliver the shares and receive $115 for them
for a $1,500 gain plus the $265 option premium.
Yes, you had your shares called away from you, but
you knew in advance at what price that might occur and what
percentage and dollar gain you would receive.
The other way to unwind your position if you wanted
to keep your shares of IBM would be to go out into the market
and buy a February call option effectively closing out the
option you wrote and shifting the responsibility to deliver
the shares to someone else.
This offsetting position might cost you more or less
than the premium you received, but would allow you to keep
your shares, which may make good tax sense for the buy and
Now another outcome needs to be factored into the mix:
even if the market price rises above $115 strike price, the
holder of the option may only be speculating on the option
contract and may never exercise the right to buy the shares
from you. (buying the shares still requires the buyer
to put up $11,500 in a cash account, where the person speculating
in the options contract only needs a couple of hundred dollars
to buy the contract.)
need to keep in mind that your option position only remains
a covered position as long as you hold the shares, if you
decide to sell your shares prior to the option expiration
you would need to go into the market and close out your position
by buying a call option matching the contract you wrote.
Writing and unwinding options contracts can get tricky.
This isnít meant to be a definitive article on writing
covered call options, but rather to give you an overview of
one of the possibilities available to our clients.
We recommend you do further reading or consult your