Selling Call Options Strategy

You can always use the strategy of writing call options on stocks that you own to earn a few quick bucks. Many investors don't do it. But, if you do, you can always earn an extra return on your portfolio of stocks.

Let's make this strategy of writing covered calls clear with an example. Suppose, you have invested $100K in stock ABC at $50 per share. You want to hold it and sell it when it reaches $55. You would have heard about Call Options. Call Options give you the right to buy or sell the underlying stocks at a certain price before a certain date.

As you are willing to sell the stock ABC at $55 by writing call options contracts, you are willing to sell to the call options contract buyer, stock ABC at $55 per share. Suppose, you write 1 month $55 call options and sell them for $2. You had invested $100K in stock ABC meaning you bought 2000 shares of ABC. Suppose the stock ABC is right now selling at $52. So, you have already made a capital gain of $4K.

You can write one options contract on 100 shares of the underlying stock. You own 2,000 shares, so you can write 10 call options contracts. If each call options contract sells for $2 per share, you earn $200 per contract and a total of $2,000. This is instant income that you can get by writing call options contracts on your portfolio of stocks. Now, let's see what can happen if you sell ten 1 month $55 call options contracts.

Suppose the stock ABC rises above $55 to $58. You will be called away at this price of $58 by the call options buyer. You make $10,000+$4,000=$14,000. If you hadn't written the call options, you would have made $16,000. But you had been planning to sell your stock ABC at the price of $55 anyway so you lose not much. However, if you want, you can buy back the call options contracts if you don't want these contracts to be exercised.

Now, consider this second case, your stock ABC trades down to $45 per share. Obviously the call options buyer will not like to exercise the options contract. You lose $5 per share but at the same time you had made $2 per share so your net loss in this case will be $3. You can use this simple strategy to hedge your downside risk.

Case 3 is stock ABC doesn't move at all. You lose nothing while at the same time making a nice income of $4,000 on your stocks that would have given you no return if you had not written the call options contracts. Good Luck!

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