Covered Calls

I know this is a non-stock blog, but I know most of you are most familiar with stocks. And, you probably have a lot of stocks that are stuck at these low points and are not moving much that you didn't sell when the market crashed. One way to make a little extra money is to sell covered calls. This is only good if you think the stock is not going to go down much or will either stay the same or go up. In order to sell a covered call, you will need level 2 access from your brokerage which is easy to get, most of the time you just have to fill out a form.

Let me give you an example of a covered call.

Say you own the stock TER (Teradyne, a company I used to work for). Say you bought it at $7. On 1/27 the stock was trading at $5.09. Now you are $2 in the hole. You probably don't want to sell it because you think it might go up. Now the stock has not moved much in the last month or so, and you are not sure what to do. So you probably want to sell it the next time it goes up or you could sell a covered call.

If you look at the options for TER, you can see that the February $5 call option is selling for .50. What does this mean? A call option is a contract written by a seller that conveys to the buyer the right — but not the obligation — to buy a stock. So if you buy a $5 call option, you have the right to buy the stock at $5 no matter what the price of the stock is. The option usually expires on the 3rd Friday of the month. Now I have learned that you don't make money buying things, you make money selling things. So, what you should be doing is selling the call option. When you sell the option, you collect the .50, or what is called the "premium."

So if you own 100 shares of TER, you can sell 1 call option (1 option gives the right to buy 100 shares). So say you sell the .50 Feb $5 call. You will get .50 upfront. So let's see what happens:

1) If the price of TER is $5.25 on 2/20 (3rd Friday) the option will execute and the person who bought the option will pay you $5 per share. So you would have gotten the .50 plus $5 for a total of $5.50/share.

2) If the price of TER < $5 on 2/20, the option will expire worthless and you can keep the .50 that was paid upfront. Of course, you would have lost money on your shares. You can always sell the option again for the next month.

3) If the price of TER is $6 on 2/20, the option will execute and you will be selling your shares for $5.50.

Now, once you sell a call, you cannot sell your shares unless you buy back the call. So if your stock is tanking, you need to buy back the option. Of course it will be cheaper than when you bought it. An option will be more valuable if the market thinks that the price will move, this usually happens before earnings come out. Also, you will receive a higher premium if there is a longer time to expiration. There is a lot more to options, but this is a good way to start. If you have questions, let me know.