How to Write Covered Call Purchases

Writing covered calls is a popular, low-risk way to earn income from the stocks you own. Call writers are actually selling the option and keeping the amount they receive for the sale. The stock is used as collateral, so there’s no need to open a margin account. As long as the stock remains lower than the option strike price, the stock owner keeps the premium as income.

Step 1

Find a stock that trades options. Use your brokerage account’s stock screener to locate stocks that are trading in a small range or in a downtrend. Look for stocks with good fundamentals in an industry that is trending up. Option contracts control 100 shares of stock, so if you want to sell two options, you must buy 200 shares. Now use the options screener to find options with volatility in the 20 to 25 percent range. Look for options trading at-the-money, with a minimum trade volume of at least 500 trades per day.

Step 2

Select the call option you want to write, which is the same thing as selling the call option. Pull up the option chain and look for a call option at least one strike above the current stock price. Decide if you want to trade the option weekly or monthly. Writing covered calls reduces the amount of money you need to purchase the stock. For example, you decide to purchase 100 shares of XYZ stock selling at $10 a share, for a total cost of $1,000. You sell a call option contract with a strike price of $15 for $2.50. Compute the option premium by multiplying the $2.50 option price times 100 stock shares for a total option premium of $250. Now subtract the $250 premium from the stock cost of $1,000, and your net cost to purchase the stock is $750.

Step 3

Go to your order entry window and select "covered call" as the order type. Enter the stock symbol, the number of shares you want to buy and the price per share. Now enter the option symbol you want to trade, the number of contracts you want to sell, and the option price. The trade will show your net debit cost for entering the trade. If the option is not exercised, you keep the premium. You can now write another covered call and earn additional income each time the option is not exercised.

Items you will need

  • Stock and options trading account

Tip

  • Select stocks with low volatility that are trading flat or in a slight uptrend.

Warning

  • If the stock price rises, and the option you wrote is exercised, the call buyer now owns your stock. Be sure the stock you write covered calls on is one you wouldn’t mind losing.

Photo Credits

  • Comstock/Comstock/Getty Images

About the Author

Based in St. Petersburg, Fla., Karen Rogers covers the financial markets for several online publications. She received a bachelor's degree in business administration from the University of South Florida.

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