How to Write Covered Calls: Use This Strategy to Kick Your Portfolio into Overdrive
by Karim Rahemtulla, Options Expert
Tuesday, August 3, 2010: Issue #1315
If you have stocks in your portfolio that you plan to keep for a while, then this will be the most important message you read today.
A bold statement, I know.
But I’m about to describe a technique that could give your portfolio a tidy boost at one of the most testing times for investors.
You see, while the stock market isn’t tanking (and let’s at least be thankful for that), it’s not exactly soaring either. What we have is something that might be even trickier – a stubborn, range-bound market that refuses to do much at all.
This means it’s trading in a narrow range, with little sign of a breakout to either the upside or downside. That’s a wicked environment if you’re counting on the market to provide income or appreciation for living expenses. What you get one day you promptly give up the next.
So what are you going to do?
Well, if you’re like 99% of ordinary investors, you’ll do nothing but watch the paint dry. If you’re the other 1%, you’re reading this column!
And by the time you’re done reading it, you’ll have a new way to make money…
Selling Covered Calls: Get Some “Free Money” From Your Portfolio
Regardless of whether the market rises or falls, there are going to be some stocks in your portfolio that you’ll want to hang onto, unless there are extenuating circumstances.
And if you’re not selling call options against those positions, you’re leaving money on the table.
It’s a strategy known as covered call writing.
And while it might sound technical, it’s really easy. All you need is at least 100 shares of a particular stock (because there are 100 shares in one option contract) and you can execute this simple strategy.
The Breakdown of a Covered Call Trade
Here’s the breakdown of a covered call trade…
Let’s assume that you buy 1,000 shares of Merck (NYSE: MRK) for $34:
- You set a target price where you’d be happy selling your Merck shares – let’s say $40 in this case.
- Find the option with the strike price closest to your target price. The Merck January $40 calls are selling for $2.
- Enter into a covered call trade, where you “sell to open” up to 10 contracts (which would be equivalent to your 1,000 shares) against your Merck position.
- If you decide to sell all 10 contracts against your 1,000-share position, the total would come to $2,000 (10 multiplied by $2 multiplied by 100 = $2,000).
This accomplishes two things…
- You pocket $2,000 for selling options that allow you to cash out of your Merck shares for $6 more than the current price. That $2,000 is yours… period. Not bad, eh?
- You reduce your overall cost in Merck to $32 ($34 minus the $2 cost of the options you sold).
Become the “Landlord” of Your Stocks With Call Options
When you sell call options against your shares that you already own, you’re getting paid to sell your shares at a higher price.
And that only happens if the shares close at or above your chosen strike price when the options expire. In the example above, the only way you sell your Merck shares would be if they either close at or above $40 by expiration or if someone is willing to pay you $40 for them anytime prior to expiration.
Think of it as collecting rent from your portfolio. And who doesn’t like collecting rent?
I show my readers how to execute trades like this all the time in my Smart Cap Alert service. In fact, we just did one on Verizon (NYSE: VZ), which is already well on its way to notching up a tidy 16% return over the next six months.
So if your portfolio is stagnating in this rangebound market, the covered call strategy is one you should strongly consider in order to boost your returns.
And if you’d like me to do all the work for you and tell you exactly what trades to make, I’d be happy to. All you need to do is join me at The Smart Cap Alert. I’ll walk you through each trade and show you what to buy and sell – and when. Covered call writing is one of the best ways I know to squeeze extra income from a tight-fisted market. Take The Smart Cap Alert for a risk-free test-drive.
Good investing,
Karim Rahemtulla
Related Investment U Articles:
- The Covered Call Strategy: Generating Income From Stocks in Any Portfolio
- How to Diversify Your Cash With DITM Covered Calls
- How to Recover When Your Option Trades Turn Against You
- Name Your Price for the Stocks You Want… And Pocket Cash for it, Too
- The “Pick Your Price” Trade That Brokers Don’t Want You to Know About
9 Responses to “How to Write Covered Calls: Use This Strategy to Kick Your Portfolio into Overdrive”
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Dubbed a "market maven" by CNBC, Karim Rahemtulla is one of the country's foremost specialists in options trading. As founder and editor of The Smart Cap Alert, he focuses his efforts on all aspects of options trading – LEAPS, put selling/covered calls and spreads. 
I like the concept of Covered Calls but have found the premiums very low. ( maybe its the stocks I own(?))
In your MRK example, the last time the Jan 11 $40 calls sold for $2 was in March 2010. Was this just an example or am I missing something ?
Thank you for your articles and insight
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Perry,
MRK in the article was just used as an example.
Thank you,
Investment U
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before I plunk down $700 I like to see one or two real sample ecommandation, form, structure, procedure etc.
can you do it?
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The above comment is the issue with this strategy if there is low volatility.
30 days is not long enough to see if you are good at recommending covered calls with your investment service, esp for a 10% fee.
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What is your strategy to protect against a large drop in the stock price.
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I’m confused;please help. As a beginning student of options, the only way your article makes sense to me is if you do not have to pay $2000 to get to 100 contracts to begin with. Is that true?? I would like to trade options, but am afraid I would be doing something wrong and would be committing myself to buy or sell something I can’t afford. Please advise.
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Chuck,
When you engage in a covered call, you first have to buy the shares. Then you sell the options against the shares that you already own. Options trade in 100 share contracts. So you are selling the equivalent number of options contracts to equal the shares that you own.
If you own 1,000 shares, as in the example, you can sell 10 contracts (10 times 100 = 1,000). For each contract that you sell at the hypothetical price of $2, you will receive $200, or $2,000 for all 10 contracts.
When you sell the contracts, you are obligating yourself to sell your shares at the strike price, in this case $40. Regardless of the outcome, you get to keep the money you received from selling the options. And, if the shares do not close at $40 or above, you also retain ownership of the shares.
You are NOT buying options in this case, but selling them against your position.
Hope this helps. If not, keep asking questions!
Investment U
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Covered calls are a great way to extract extra value from your existing portfolio, as stated. But they can be used for extra income each week thanks to the new weekly options, too. You buy some diversified ETF (like IWM) on Monday, and then sell an ITM CC that expires that Friday. It’s like getting 52 dividends per year.
MikeS
http://www.borntosell.com
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What about the strategy of selling the covered calls on 50% of your position. I own 1600 shares od PWER at $11.77. When the November 21st calls come out August 21st, I sell 8 call contracts at whatever the price is, lock in those profits and keep the rest in case it blows through the strike price???
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