How to Write
Covered Calls

Covered Calls

Call options give the option buyer rights to buy stock (from the option seller) at strike price.  Call options are covered calls when the option seller is long stock that the covered calls are written against.

Buy-Write Covered Calls Strategy

We recommend you treat stock as a commodity, traded to generate monthly income.  When writing covered calls it's important that you like the stock's short-term potential and to buy stock that's going up.

By writing covered calls, you're making monthly income by selling upside potential of stock to speculators.  It's to your advantage if the stock is called away.  If you sell low risk ITM covered calls, your profit ((strike price+premium) - stock cost) is locked in when you sell the covered calls.

When you write covered calls you must do one of the following:

• If exercised, sell stock to the option buyer at strike price anytime before expiration.
• Buy the calls back on the open market before exercise.
• Let the calls expire unexercised (on the third Friday).

In-the-Money Covered Calls

If you're not thoroughly convinced of a rise in stock price and expect some sideways movement, write ITM covered calls.  The advantage of ITM covered calls is better downside protection.  You profit regardless of the direction of the stock.

For instance, if you purchase 100 shares of stock for $10.75 per share, you could write a $10 ITM covered call and get a premium of, say, $1.50.

If the stock does close above $10 at option expiration, it will be called for $10.  You still make a profit because your cost is only $9.25.

Otherwise, if the stock doesn't close above $10 at option expiration, it won't be called.  You could then either sell the stock or write a covered call against it for next month.  As long as it's above $9.25, you profit.

Out-of-the-money Covered Calls

If you're very bullish on a stock, write OTM covered calls.  Then you have potential for some extra profit, but there is very little downside protection.  This strategy is more like a long stock position than a premium collection strategy.

If you purchase 100 shares of stock for $4.75 per share, you could write a $5 OTM covered call and get a premium of, say, $0.50.

If the stock does close above $5 at option expiration, it will be called for $5 producing a $0.25 capital gain in addition to the premium.

Otherwise, if the stock doesn't close above $5 at option expiration, it won't be called.  You could then either sell the stock or write covered calls against it for next month.  As long as it's above $4.25, you profit.

• If the stock goes above $5 before expiration and you don't want it called, roll up or roll forward.
• If it has declined and you don't want to keep it, close your call and sell the stock, or roll down.