Additional income through covered call option strategy

on Jun 14, 2012 in Derivative, Equity, Home | 2,509 comments

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During times of economic uncertainty, having blue chip titles in your portfolio that pay  steady dividends is one way to ride out the storm. Dividends provide indeed regular  income to investors. But did you know you could earn an extra income on shares you already own?

This strategy involves selling covered calls on shares that you own. By using a covered call option strategy, the investor gets a premium writing calls and at the same time enjoys all benefits of share ownership, such as dividends and voting rights, unless he is  exercised on the written call and is then obligated to sell his shares.

It is also important to cover a caveat of this strategy. When you sell a covered call on a share, you are limiting your upside potential. If the share price goes skyward then the option will probably be exercised and you will be obligated to sell the share at the agreed on strike price.

However, if the asset price is below the strike price at expiration, then the calls that you sold are not exercised and the premium that you collected provides additional income for you, increasing your rate of return on your portfolio.

If you are writing out of the money calls, the share may continually increase in value, yet the options may never get exercised, allowing you to simply roll over the strategy. This generates continuous income for you.

Obviously, you want to sell covered calls at a strike price above your cost basis, so you still profit if the market price is above the strike price and the shares are called. Ideally you would like to set the strike price above where you believe the price will rise by the expiration date, so that you can pocket both the premium and keep the shares within your portfolio.

When your view is neutral on a share and you want to generate additional income from your investments, this option strategy is worth your consideration.