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Gain Extra Income from Your Stocks
01/11/2013 8:30 am EST
It's a relatively easy and well-known strategy, but many investors still do not take full advantage of covered call writing to maximize income, says Mark Wolfinger.
We're here with Mark Wolfinger, who's going to explain the process of using options to get more money from your stocks.
Yes, an investor can generate extra income for stocks he/she owns. It's called covered call writing. The idea is you own 100 shares of stock and you sell one call option. That call option pays you a premium. It's yours to keep forever.
In return for buying the call option, the owner has the right to buy your stock at the strike price; a predetermined price. You'll know in advance what that price is. The buyer of the option will know in advance what that price is, so if that call owner wants to, he can buy your stock at any time before the option expires.
If the stock doesn't go high enough so that this person doesn't call your stock away, take your stock, you get to keep your stock and you get to keep the premium...which you already kept, but it's your premium and it's extra income. You can write another call and another call every time one expires.
However, at some point, the stock may rise and remain above that strike price. So, if you have sold someone else the right to buy your stock at $55 a share and if stock is $60, well that person is going to exercise his rights and buy your stock at $55. Now, you've still kept the option premium, you earned your extra income, but now you've given up the potential for a big gain because the owner of that option has taken your stock at $55.
So this is a great method for increasing income. I like to think of it as getting extra dividends-although they're not taxed as dividends-getting extra dividends every month or two or three, but in exchange you have to give up the chance to make a big gain because if the stock runs beyond a certain point someone is going to buy it.
So, I recommend this for the income-oriented trader who wants more income, and although bullish on his stock is willing to limit the upside in order to get these extra dividends.
And so I would assume that it works in flat markets like we had, not as much this year but in past years. This is good because if you don't want your stock called away obviously, or with stocks that are pretty steady, stocks that aren't moving in 10% or 20% increments month to month but are like some of the durables and industrials and things of that nature...you can just play this game with them month to month to month.
Yes. You're right. You can do that. I want to mention one problem with that.
First, this is a good time. When markets are generally not too volatile, that's what most corporate call writers like. They want to sell the premium. They want to collect that extra dividend and they don't want to lose their stock.
For me, if the stock is $52 a share and I've sold someone the right to buy it at $55, hey, I'm thrilled if it goes to $55. I get to keep my premium and I get my $300 in capital gain. But most traders would prefer the keep their stock.
So, yes, that's an ideal situation, a steady market, slightly up, slightly down, not volatile market. It's ideal for covered call writing.
Now, what you said about non-volatile stocks is true. That's ideal. However, when stocks aren't very volatile the option buyers don't pay very much premium, because if you're buying an option you profit when it takes a big move.
Stocks that are not likely to take a big move pay a small premium, so that's fine. You know, if you have an ExxonMobil (XOM) or some such dividend-paying stock that's not really volatile, it's fine to go for the extra dividend. But if you want to try to get a large extra dividend-a nice chunk of premium for your call option that you're selling-it can't be one of those stocks you just buy.
You're going to take on more risk or implied volatility and you might get your stock called away.
That's exactly what makes the call worth a lot of money, but it's a bad idea to just buy some volatile stock with the intention of writing a covered call. This volatile stock can move down.
So even though the premium is attractive, I recommend covered call writing only for stocks you want to own are willing to own, not just some random trade where you're hoping to make a quick profit.
Right, and these are income investors for the most part, so they're going to be safety first type of people.
And they're not going to want their stock called away because they've probably held it for a long time, the tax implications. It's a fascinating strategy. I thank you very much for coming and sharing it with us.
One more point. If you really don't want to sell your stock for tax reasons, you have to be very careful. Maybe writing covered calls isn't the best way to do this. You can do something that's very similar-that would be selling the cash in your put, for example-but you do have to recognize that there's always a chance that you will lose your stock.
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