What’s a Covered Call? Bare-Bones Basics

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One of the best ways to boost your income is with a covered call.

In this type of options strategy, you already hold a stock position. Then, you sell a call option on the same stock. Let’s say you held 200 shares of ABC. To then create a covered call, you would also sell two contracts of the ABC stock. That way you own 200 shares of ABC, and are selling two contracts, which hold a total of 200 shares of the same stock.

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As we noted on July 30, quoting Ally Financial: “When you write a covered call, you are selling someone else the right to purchase stock that you already own, at a specific price (called the strike price) and within a specific time frame. Since a single option contract usually represents 100 shares, you have to own at least that amount (or more) for every call contract you plan to sell to utilize this strategy.”

Trust me, it gets much easier with practice.

Typically, a covered call can help you generate income, if you believe a stock price is unlikely to rise much prior to your chosen expiration date. At the same time, a covered call can limit your upside, and won’t offer much in the way of protection if the stock price drops under your strike.

If everything works out as it should, here’s your expected outcome: Let’s say you buy 200 shares of ABC, and then sell two contracts against it, each carrying 100 shares (so, 200 shares in total). Let’s also say the ABC calls you’re selling traded at $5 (premium), and the option is exercisable at a strike price of, say, $65.

Then, by the expiration date, the option closes at $70. Because it’s above the $65 strike, the option is exercised, and you then receive a profit of $5 (the difference between the $70 close and the $65 strike price), in addition to the $5 premium you received from the sale of the option.

That’s one way to trade covered calls.

Another way to trade these calls is with an ETF, such as the ones we mentioned on July 30.

  • The NASDAQ 100 Covered Call ETF (QYLD) writes call options on the NASDAQ-100
  • The Global X S&P 500 Covered Call ETF (XYLD) writes call options on the S&P 500
  • Global X NASDAQ 100 Covered Call and Growth ETF (QYLG) writes calls on stocks on the NASDAQ 100 Index.

Again, with practice, the covered call strategy gets much easier to understand.

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