Sunday, February 23, 2014

Another Way to Making Money in the Markets - Pt #2

This post will discuss a second way to make income besides dividends.  Part #1 was about  selling puts .  

A second way to make more money in the markets would be to sell covered calls.  If you own 100 shares of a stock, you can sell a call option, which makes it a covered call, against the stock. The investor receives an option premium minus commissions upfront as they will be obligated to sell the stock at the strike price if the option is exercised.  The downside is that the stock could increase a lot and the investor misses out the option is exercised at the strike price.


Figure 1


 In the diagram above (Figure 2 ), the profit is limited to the upside which occurs at the strike price. This max profit equals the the capital gain from sale at strike price plus the option premium. The downside risk is lowered by the amount of the option premium. In the diagram above, if we sold the stock at $760.00 without selling  a covered call the profit would be lowered by an amount equal to the option premium.

NOTE: If you sell a call option without owning the underlying stock this is called selling a naked call. The premium is still received up front. If the option is exercised, the loss is unlimited as the individual would have to buy the stock in the open market and then sell it at the strike price. Selling naked calls is one of the most riskiest option strategies and definitely only experienced option traders should use.


Photo Credit : en.wikipedia.org

DISCLAIMER:

     I am not a financial planner, financial advisor, accountant or tax attorney. The information on this blog represents my own thoughts and opinions and should NOT be taken as investment or business advice.  Every individual should do their due diligence to make their own financial decisions based on their financial situation and tolerance for risk
    

1 comment:

  1. Covered calls are my favorite, I usually use them after a stock has run up then I use it as a way to benefit and protect from giving back some gains. Nice work.

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