A Cabot Primer: How to Write Covered Calls
Writing covered calls is a great way to boost your yield on stocks you already own, and involves a lot less risk than most investors think, explains dividend expert Chloe Lutts Jensen, editor of Cabot Dividend Investor.
A call option gives the owner the right to buy a stock at a certain price (the strike price). When you sell call options on stocks you own, you’re selling some other investor (your counterparty) the right to buy that stock from you in the future, if the price hits your strike price.
For example, let’s say I own Coca-Cola (KO), which is currently trading around 43. If I sell a KO call option that expires in June and has a strike price of 45, one of two things could happen:
Option 1: KO stays below 45 until the call expires in June. I get to keep my KO stock, and the amount I sold the call for (which is called premium).
Option 2: KO rises above 45 before my call expires. The person who bought the call from me exercises the call, buying the stock from me for $45 per share. I get the money from the sale and the call premium, but I don’t own the stock any more.
How to Write Covered Calls
To write a covered call, choose a stock you already own and for which there is an options market. Decide how many calls you would like to write (writing means selling). Each call gives the owner the right to buy 100 shares of that stock, so if you own 200 shares of Coca-Cola (KO), you can write two calls.
Since the option will only get exercised if the stock rises, the best stocks to use (assuming you want to keep them) are stocks that you don’t think will go up right away.