For many years buying stock and holding it until you retired or until the share price had risen exponentially was the common school of thought. But with stock markets domestic and abroad in uncertain territory, many are starting to search for an alternative to the ‘buy and hold’ trading strategy.
Buy and hold…alive and well.
What if there was a way to still capitalize on holding your stock long term? Once such way is by writing covered calls on the stocks you already own. Writing covered calls or selling call options lets you generate a monthly income by giving someone the right to buy your stock.
One benefit to this option trading strategy is that you can implement it without purchasing new shares. As long as you have a least 100 shares of any one stock you can start generating an extra monthly premium immediately.
Even no movement is profitable.
In a market that is moving up or sideways, selling covered calls can be an increasingly profitable investing technique. The less movement the market or your particular stock has, the less likely you are to be ‘called out’ when writing covered calls.
Volatility can be your enemy when selling covered calls as a strategy.
However, a stock could hover around the same price for an entire year and you could still generate profit from owning it every single month. In short: you don’t need the stock to move higher to make money selling calls.
What happens if the market heads lower?
You can always buy back the call options you sold thus closing out the position. If
things became too dire, the option exists of selling the shares of stock after you have bought the call options back.
Don’t want to sell your stock even though the market’s heading south? Consider buying a put option which would increase in value as the price of the stock decreases.
Buying a put in this instance would be more of an insurance policy than a money making strategy.
So if the stock or the market in general head into negative territory, how do you know
when to buy the call option back and consider potentially selling the stock?
Very simple calculation: whatever premium you collected when you sold your calls is the first break even point. Collect $150 from selling one contract ($1.50 x 100) then your stopping point would be $1.50 less than what the stock was when you sold the covered calls.
Whatever the price one option was sold for, in this case, it was $1.50, becomes the limit to how far the stock can drop before your profit from writing the calls vanishes.
If you have been writing covered calls on a stock for more than a month your overall break even could be lower if you add up all the monthly income generated since beginning this strategy.
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