Recommended Option Strategies #1: Covered Call Writing

There
are six strategies I recommend for option traders. There are other good strategies available,
but these are the ones I use for my own trading and each is easy to understand. At the top of the list is covered call
writing.

This
is a wonderful way for rookies to learn all about options and gain experience
buying and selling call options.

Most
option rookies already understand the stock market and have investing
experience. Thus, beginning with an
options strategy that includes stock ownership is a logical way to introduce
investors to the world of stock options.

Definition: Covered call writing – The sale of a call
option that is backed (covered) by 100 shares of stock for each option.

To
implement this strategy, buy 100 shares (or more, in multiples of 100), or use
shares you already own, and sell one call option for each 100 shares.

When
you sell a call option, you collect a cash premium that is yours to keep, no
matter what happens in the future.

When
you sell a call option

  • You become
    obligated to sell 100 shares of stock at a specific price, known as the strike
    price – but only when the option owner elects to 'exercise' the option.  You, as the option seller, have nothing to say about that decision.
  • Both you and the
    call buyer agreed upon the strike price when you sold the call option.
  • The obligation to
    sell your shares lasts for a limited time – until the expiration date. If the option owner fails to exercise when
    that date arrives, your obligation ends and the call option expires worthless.

 

When
you are assigned an exercise notice, it’s nothing to alarm you. It’s simply a report from your broker stating that the option has
been exercised and that you must sell your shares at the strike price.

 

There is much
more to this strategy. You must choose
an appropriate stock to own.  When selling an option, you must choose a strike price and expiration month. There are always at least three strike prices
and four expiration months from which to choose. It may seem complicated at first, but if you practice
in a paper trading account, you’ll learn how to select appropriate options to sell.


Part II.

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