Writing Call Options Can Give You A Quick Income As Well As Hedge Your Stock Portfolio
Suppose you have invested in a portfolio of liquid stocks something like $100K. How about making a quick return on your investment instantly anytime you want with this option strategy. If you have an investment in stocks, this options strategy can give you an instant income. Learn how to make the money in your trading account work harder with this strategy.
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.
Now each options contract represents 100 shares. So, you can write 20 call options contracts on your stock ABC. Each options contract will give you $200 return. Your total return by selling 20 call options contracts will be $4,000. Let's see how your strategy of writing call options works.
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.
Consider the second case stock ABC goes down in price to $45 per share. Now, obviously the call options buyer will never like to buy that stock at $55 per share if it can be bought at $45 per share. So, the contracts expire without any obligation on your part. You lose $5 per share but at the same time make $2 per share by selling call options contracts. So, your net loss is only $3 per share. You can see how writing call options contracts had hedged your downside risk. You can again write 1 month $50 call options contract to recover part of that loss. Suppose these contracts sell for $1 per share, so you further reduce your loss to only $2 per share.
The third possibility is that stock ABC neither moves up nor down. You lose nothing in this case but make $4,000. So writing call options on your portfolio of stocks can be a good way to make instant income!
Article Source: FxTradingStock.com
About the Author
Mr. Ahmad Hassam has done Masters from Harvard University. Watch this weird 30 minutes Stock Trading Video just now. Turn $200 into $100K in just 1 month with this FREE Penny Stock Trading Report that shows how to find killer penny stocks about to make a big move in the market.
by: Ahmad Hassam
Total views: 36
Word Count: 481
Date: Wed, 8 Dec 2010
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