After taking an honest look at your own finances, you may decide you really do need extra income. Perhaps you want to fund a hobby, or you are one of the few lucky ones with extra time on your hands, or even want to find a different investment opportunity. Covered calls are one opportunity you can exercise in order to pull in extra income with investments you already have or can acquire.
What are Covered Calls?
Covered calls are an option one can sell on investments they already own. The option is to purchase the underlying investment at a strike price before a certain date. The hope for the seller of the covered call, is that the option is purchased and never exercised, allowing them to sell the option repeatedly to generate a consistent flow of income. This will happen if the underlying investment value remains below the strike price. If the investment value exceeds the strike price, you will be forced to sell the investment at the lower strike price, but you will keep the amount you sold the option for.
What do I need to start?
In order to start selling covered calls, you need to have investments. Certain investments will be better than others based on your expectations of their future performance. As stated above, investments you expect to remain constant in value, or to decline (and which you don't otherwise want to sell), are best investments for covered calls. Of course, the if the entire market agrees with you that the investment will not increase in value then no one will purchase your option to begin with, so obviously, you need to have an investment whose future is at least somewhat uncertain at the time of the option sale. Barring insider trading (which is illegal), predicting the future can be difficult, but also can be worth the rewards if you are willing to take the risks.
What are the risks?
The risks of covered calls are the same as with any option and with any stock investment. With the option itself, you put at risk only the difference between the increase in value of the stock and the strike price – thereby limiting the gain you can make if the price of the stock does increase. However, owning the underlying investment also presents a risk that is not eliminated by using covered calls. By owning the stock, you are risking the entire value of that stock, as you are when you invest in anything. Because the options are 'covered', that is, you own the underlying stock at the time of the option sale, you are limiting your risk as opposed to when the option is 'naked' where you will have to purchase the underlying stock at market price in order to sell it to the option buyer at the strike price if they exercise the option.
How do I get started?
There is a lot of information about covered calls available on the internet and in investment books. One such source is Compound Stock Earnings. Always remember, however, that options are bets on the future performance of the stock market and are not a guaranteed source of income. If you do choose to invest in covered calls, be sure you are using funds you don't necessarily need to survive (or retire) on.
