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Selling a covered call is a strategy in options trading where you sell a call option against a stock (or another asset) that you already own. It can help you generate additional income from the premiums received for selling the call option, while still holding the underlying stock. Here's how to sell a covered call step by step:
1. Own the Underlying Stock
You need to own 100 shares of the stock for each options contract you want to sell (since each option contract represents 100 shares). For example, if you own 100 shares of XYZ stock, you can sell 1 call option contract for XYZ.
2. Choose the Right Strike Price
The strike price is the price at which the buyer of the call option has the right to buy your stock.
You'll want to choose a strike price higher than the current price of the stock. This means that you keep the potential for upside growth in the stock, but if the stock price rises above the strike price, your stock will likely be called away (you'll be forced to sell it at that price).
3. Pick the Expiration Date
Choose an expiration date for the call option. This is how long the buyer has the right to buy your stock at the strike price. The longer the time to expiration, the higher the premium you can receive for selling the option.
4. Sell the Call Option
Once you've selected the strike price and expiration, go to your brokerage platform and choose the option to sell a call. This is where you'll enter the details, such as:
Sell to open: This is how you initiate the position.
Number of contracts: Typically, 1 contract = 100 shares.
Strike price: The price at which you're willing to sell your shares.
Expiration date: When the option will expire.
The price you receive for selling the option is the premium. This is income you earn upfront, regardless of whether the option ends up being exercised.
5. Monitor the Position
After selling the covered call, you need to monitor both the stock and the options position. If the stock price rises above the strike price, your stock may be called away (i.e., you will be required to sell it at that strike price).
If the stock price remains below the strike price, you keep the stock and the premium received from selling the call option.
6. Potential Outcomes
Stock price stays below the strike price: The option expires worthless, and you keep the premium and your stock.
Stock price rises above the strike price: Your stock may be called away, meaning you sell your stock at the strike price, but you still keep the premium you received from selling the call.
Stock price falls: You still keep the premium, but your stock's value has decreased. However, the premium you received offers some downside protection.
Example:
Let's say you own 100 shares of XYZ stock, and the current stock price is $50. You sell a covered call with a strike price of $55 and an expiration in 30 days, receiving a premium of $2 per share.
If the stock price stays below $55, you keep your stock and the $2 per share premium.
If the stock price goes above $55, your stock will be called away, and you'll sell it for $55 per share. You also keep the $2 premium, so your effective selling price is $57 ($55 + $2).
Risks:
Limited upside: If the stock price rises significantly above the strike price, you miss out on the additional upside since you'll have to sell your stock at the strike price.
Downside risk: You still bear the risk of the stock falling in value, although the premium received offers some cushion.
A covered call is a great strategy if you're neutral to moderately bullish on the stock and want to generate income while holding it.
