If you’re interested in investing in the stock market, you might have heard about a covered call strategy. It’s a popular method that can help you generate income while holding onto your stocks. Here’s a simple guide on how to execute a covered call strategy.
First, let’s understand what a covered call is. A covered call is an options trading strategy where an investor sells a call option on a stock they already own. When you sell a call option, you’re agreeing to sell your stock at a specific price (known as the strike price) to the buyer of the option if they choose to exercise it.
Now, let’s get to the steps of executing a covered call strategy:
Step 1: Choose a stock to invest in
You’ll need to pick a stock that you’re comfortable holding for the long term. This is because when you sell a call option, you’re agreeing to sell your shares if the option is exercised, and you don’t want to be forced to sell a stock you’re not comfortable holding.
Step 2: Determine the strike price and expiration date of the call option
You’ll need to decide at what price you’re willing to sell your shares if the call option is exercised. This is known as the strike price. You’ll also need to choose an expiration date for the option. This is the date by which the buyer of the option must decide whether to exercise it or not.
Working with a financial advisor can be essential for determining the right strike price for a stock when executing a covered call strategy. Financial advisors have the knowledge and experience to analyze market trends, evaluate the risk-reward potential of different stocks, and help you make informed decisions about your investments.
Step 3: Sell the call option
Once you’ve chosen the stock, strike price, and expiration date, you’ll need to sell the call option. You can do this through a broker or trading platform. The buyer of the option pays you a premium for the right to buy your stock at the strike price before the expiration date.
The result of the premium that you are paid is yours, it can be transferred and used elsewhere, or reinvested to continue your other investment efforts.
Step 4: Wait and see what happens
Now you wait and see if the buyer of the option decides to exercise it or not. If the stock price stays below the strike price, the option will expire worthless, and you’ll keep the premium you received for selling the option. If the stock price rises above the strike price, the buyer of the option will likely exercise it, and you’ll sell your shares at the strike price.
Step 5: Repeat the process
If the option is not exercised, you can repeat the process and sell another call option on the same stock. You can continue to generate income from selling call options on the same stock as long as you’re comfortable holding onto it.
To sum it up, executing a covered call strategy involves selling a call option on a stock you already own. By doing so, you receive a premium and generate income while holding onto your shares. Just remember to choose a stock you’re comfortable holding for the long term and to pick a strike price and expiration date that makes sense for your investment goals.
Covered call options are one of the many risk management strategies we at InSight develop with clients to help them achieve their financial and risk targets. Contact us today if you have concentrated positions and excess risk from a single stock position.