Monday, May 30, 2011

What are Covered Calls?

Covered calls are a way to generate monthly income and wealth on a stock purchase. In a covered call an investor buys 100 shares of a stock and sells someone else the right but not the obligation to purchase the shares from them (a contract) at a certain price up to a certain date. Another way to look at this is to think about real estate. If a person purchased a property for $100,000 dollars and rented the property to someone for $1000 dollars per month, then they would be earning a 1% return per month on their investment, with a positive income or cashflow of 1000 dollars. The covered call strategy allows the person who buys stock to treat their shares of stock like a property, generating monthly income through cashflow. There are only two possible scenarios that can take place with a Covered Call.

In Scenario #1, the stock will be above the sell price (Assigned/Called). If the stock is above the sell price then the stock will be taken away from the seller and the seller will receive the amount of money they sold the stock for in there account and also keep the premium or rental that they received. This is known as being assigned or having your stock called away.

In Scenario #2 , the stock will be below the sell price (Expire worthless/ Uncalled). If the stock is below the sell price then the seller will keep the stock and keep the premium because the buyers contract has expired worthless or been uncalled. The owner of the stock can then sell another contract or "rent" out the stock again the following month.

Please watch the following video.