Covered Call Example

Let's look at a covered call example:

You own 100 shares of XYZ stock trading around $45.

Imagine you're willing to sell it if it goes up 10% (to $50) in the next 3-4 weeks.

You call your broker and say "Sell the near month call option on XYZ with a strike price of 50."

Your broker informs you that the call option is trading for $1 today. Since you have 100 shares, you get $100 today (ignoring commissions to keep it simple). That money is deposited into your account today.

So what have you done?

In exchange for the $100 you received today, you have agreed to sell your 100 shares of XYZ stock for $50/share any time before (and including) the 3rd Friday of the month (remember, the stock is at $45 today).

If the stock is over $50 on option expiration day then the person who bought your call option will exercise it -- meaning they will buy your stock from you for $50/share.

So you get $5,000 plus the original $100 from selling the option, for a total of $5,100 cash into your account.

If the stock is at or below $50 on option expiration day then the call option expires worthless. This is good for you since you sold the call option to someone else. You keep the $100 premium, and you keep your stock (with no further obligation).

Now you can sell another call option against the same stock for the following month. This is what we mean when we say "generate recurring monthly income from stocks you own."

Now, $100 is not a big number but this covered call example was only 100 shares for 1 month and, more important, on a percentage basis the $100 monthly income is over 2% of the cost of the stock (which was $4,500 in this example). You can repeat this process every month. (see blog article How To Write Covered Call Options)

Think about it: 2%/month = 24%/year.
(with less risk than a simple buy and hold strategy, see how on the next page)

Some covered calls will pay 3%, or sometimes even more, per month and this site will help you find them. Of course, you don't want to select stocks based on the call premium alone. Company research is required, too. And if you select stocks that pay dividends (we'll help you find them) then you will get the normal dividend plus monthly call premium.

Previous | Next