Friday, November 20, 2009

Covered Call Options: Part 1 – What Are Covered Call Options?

Options are mysterious and arcane. They’re the black magic of investing. Few understand them and fewer make money with them. But there is one straight-forward class of options and the way to use them to make money is clear – writing covered calls.

Writing a covered call means selling to someone else an option to buy your stock. A single covered call options contract gives the buyer the right to purchase 100 shares of your stock in the specified company (the underlying stock).

Since not all stocks have options contracts, the first requirement to sell (or write) a covered call option is that you must own at least 100 shares of a stock for which options are traded. So check with your broker to see if options are traded for your stock.

When you have at least 100 shares of a stock that has options trading, your next task is to determine your broker’s commission structure for writing covered call options contracts. My broker charges a flat rate per transaction plus a surcharge for each 100 share contract in the trade. This has the effect of reducing the cost per contract on multiple contract transactions. I have only used one broker for selling covered calls so I don’t know if this commission structure is standard. In any case, you need to determine exactly what your broker will charge.

The commission structure is very important because the prices of options contracts vary all over the place and you want to be sure that when you sell your covered call you make enough money on the sale to pay the commission and a profit large enough to make it worth the trouble

The next post will review some basic options definitions.

Links to Other Topics in the Special Report: Covered Call Options

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