Selling covered calls is a means in which one can leverage long stock positions to extract residual income on a regular basis via premium income. The owner of the shares sells the right the option buyer to buy the shares at an agreed upon price by an agreed upon date. From the option buyer's perspective, if the shares increase in value above the agreed upon price, then the option buyer would exercise the option and elect to buy the shares. The shares in this example would be acquired at a lower price (agreed upon strike) relative to the open market price. Conversely, if the share price stays below the agreed upon price then the option buyer would not exercise the option to buy shares since the agreed upon price was higher than the market price. Thus, the option buyer would not buy shares at a higher, agreed upon strike price relative to the market price.
As the owner of the long stock, the ideal scenario is to continue to own the stock will collecting premium income on a monthly basis without relinquishing the stock. Thus, the owner of the stock allows for an upward buffer of price appreciation since the agreed upon price would be higher than the current market price. In this scenario, as market conditions decline, move sideways or appreciate to a certain degree the stock will be retained while collecting residual income on a regular basis. Covered call trades can easily be identified using the options screening software to screen 70 different stocks and ETFs, specifically taking into account dividend dates to retain the dividend payout for the underlying stock when selecting the options expiration date.
Selling a call option will take on the obligation to sell the shares of interest. For instance, he/she is taking on the obligation to sell shares at $105 a month from now when the current price is $100. The seller of the call contract believes the shares will not appreciate beyond the $105 level prior to expiration. Thus the owner of the shares would collect the option premium and retain the shares while the call buyer would lose the premium paid and end up without any shares. In this case, the call option seller collects a premium from the call option buyer and makes money while leveraging the shares.
The buyer of the call contract believes the shares will rise above the $105 level within this time frame. If the shares appreciate above $105 per share, the owner of the shares would relinquish shares to the call buyer. Why buy the shares above $105 on the open market when the call option buyer can buy them from the call seller for $105? This is effectively a residual income attempt via leveraging the shares on a monthly basis. In this case, the call option seller collects a premium from the call option buyer and relinquishes shares at the strike of $105 per share.
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