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Covered Call Options FAQ and Trading Strategy

By Erik Twitchell

There are a few new terms and concepts to learn when you first begin learning about covered calls. They're not that difficult, and covered calls are similar in many ways to other investment concepts. It is important to find good sources of information and to understand as much as you can before investing your money. Covered calls can be a good money making source, but they are not a fast path to instant riches. If you are looking to become wealthy overnight, then this is probably not the right strategy for you. But if you are interested in a reliable way to earn recurring monthly income, then covered calls make a good choice.

Here are some commonly asked questions among new investors:

Covered calls are what, exactly?

A covered call is an investment in two parts. First, buy 100 or more shares of stock. Second, sell a call option against that stock. Options control 100 shares each, so you sell one call option for every 100 shares of stock you bought (if you bought 500 shares you could sell 5 call options, for example). The combination long stock + short call option is known as a "covered call".

What do "long" and "short" mean?

When you own a security, then you are considered to be "long" and when you are "short" a security, it simply means you are selling it without actually owning it. You will then have to purchase it at some time in the future.

Great. I like profits. Where does the making money part come in?

You make money by selling call options to other investors. The "premium" (money) you receive is yours to keep, no matter what happens to the underlying stock. Once the option expires you can sell another one.

When is a good time to sell call options?

Generally speaking, you are trading future upside of a given stock for the right to make money short term instead. Given this, you would sell call options on stocks that you expect to remain fairly flat in the near future. If stock A is bought at $50 per share, and you expect it to stay at or near that mark for a period of time, then selling options is a good idea. This is the basic idea, although a trusted source of information can give you much deeper investment advice to narrow the choices further. Obviously you would not want to do this on a stock you expect to skyrocket in the near future, as you lose too much upside.

Investing in covered calls is not difficult. It is the most common options-based investment strategy (Schwab says 84% of their option enabled accounts will do covered calls). Having a good covered call screener at your side will save you time (much better than a manual spreadsheet). If you're not selling calls against stocks you already own then you're leaving money on the table each month.

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