Income Generating Strategies: Covered Calls & Put Options – Moneyshow.com (registration)

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Sponsored Content—“There’s no such thing as a free lunch” is a frequently heard commercial saying. When looking at income generating strategies for equity options, perhaps a better guideline is the relationship between risk and return–what risk am I taking for what return? Am I happy with that level of risk?

The covered call

In the recent low interest rate environment, many holders of stock have been keen to enhance their returns from that stock by writing (selling) calls backed by those stocks.

For detailed information on the construction of the covered call, go to OIC’s website

Figure 1 shows the profit and loss on the combined stock and option position at expiration.

chart 1

The strategy involves writing a call that is covered by an equivalent long stock position. The income received from the call option sold provides a small hedge on the stock and allows an investor to earn premium income, in return for temporarily surrendering some of the stock’s upside potential.

The covered call can be a good way to enhance the return on a stock already held during sideways or range bound market conditions. It is not suitable for markets experiencing dramatic up or down moves. One way to look at the covered call is to see the premium received not only as extra income, but also as a buffer should the position not turn out as expected.

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