Writing Call Options Can Give You A Quick Income
Suppose you have invested in a portfolio of liquid stocks something like $100K. How about making a quick return on your investment instantly anytime you want with this option strategy. If you have an investment in stocks, this options strategy can give you an instant income. Learn how to make the money in your trading account work harder with this strategy.
Let's make this strategy of writing covered calls clear with an example. Suppose, you have invested $100K in stock ABC at $50 per share. You want to hold it and sell it when it reaches $55. You would have heard about Call Options. Call Options give you the right to buy or sell the underlying stocks at a certain price before a certain date.
You plan to write call options on your shares of ABC. You are willing to sell your stock in the next 1 months if it reaches the price of $55. You find that ABC 1 months $55 calls are selling for $2. Right now, the stock ABC is trading at $52. This means a profit of $2 per share or a capital gain of $4000 on the 2000 shares of stock ABC.
You can write one options contract on 100 shares of the underlying stock. You own 2,000 shares, so you can write 10 call options contracts. If each call options contract sells for $2 per share, you earn $200 per contract and a total of $2,000. This is instant income that you can get by writing call options contracts on your portfolio of stocks. Now, let's see what can happen if you sell ten 1 month $55 call options contracts.
Let's consider the first scenario. Stock ABC rises to $58 instead of $55. You are bound to sell stock ABC to the call options contract buyer for $55. So, you lose $3 per share but at the same time you had made $2 per share by selling the contracts. So, there is a tradeoff here. If you feel that the stock price is on the rise, you can always buy back your options contract something also know as call back.
Consider the second case stock ABC goes down in price to $45 per share. Now, obviously the call options buyer will never like to buy that stock at $55 per share if it can be bought at $45 per share. So, the contracts expire without any obligation on your part. You lose $5 per share but at the same time make $2 per share by selling call options contracts. So, your net loss is only $3 per share. You can see how writing call options contracts had hedged your downside risk. You can again write 1 month $50 call options contract to recover part of that loss. Suppose these contracts sell for $1 per share, so you further reduce your loss to only $2 per share.
The third possibility is that stock ABC neither moves up nor down. You lose nothing in this case but make $4,000. So writing call options on your portfolio of stocks can be a good way to make instant income!
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