How to Use Covered Call Options For Additional Safety and Profit

If you buy stock, you expect that the price of the stock will go up, and you will be able to sell your stock and make money. If the price of the stock falls, you will sell it for a loss. Call options can be used in either situation -- to enhance the profits of rising stock, or reduce the loss from falling stock. In today's erratic economy, it is essential that investors understand options and use them for safer investing.
One easy way to start with options is by selling a call option when you buy stock. This combination of buying stock and selling call options is referred to as a "covered call" or a "buy-write". Here's how it works.

You buy 100 shares of stock, and at the same time (or later) you sell one call option. You may then be obligated to sell the stock at a pre-determined price before the option expires (usually within 45 days or so). If you set the pre-determined price high, the option is likely to expire and become worthless. If you set the pre-determined price low, it is likely that you will sell the stock on expiration day for that price.

Let's see a specific example. Suppose it is Jan 12, and Apple (AAPL) is selling for $89. I want to add the protection that call options bring. I buy 100 shares of AAPL, and sell the February 90 Call option for $6.00. This means that my net cost is $84. As long as the price of AAPL stays below 90 until February 20, the option will expire worthless, and I get to keep the $6.00. This adds a few percentage points to my monthly return and provides protection in case AAPL falls a little. If AAPL rises above 90, I will sell it at 90, keeping the $1.00 profit on the stock, and the $6.00 from the sale of the option. That's about 10% in a month. Essentially, you can lock in some profit every month. Some people use options for speculation and gambling. Some are successful, but many are not. I use options for a safe investing strategy.

The covered call can be used in several different ways depending on the market and the investment results desired. There are also several other more advanced options strategies that use selling call option to provide additional income.