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Introduction
Thank you for taking the time to drop by. In this blog I will discuss an options trade you can make with investments you already own in order to make extra income. I would appreciate that if you enjoyed this article that you give it a vote, leave a comment and re-steem it! Thank you!
Selling Covered Calls
Selling covered calls are an excellent way to earn extra money on your investments. A covered call is a lot like saying "I will sell my stock to you if it reaches this price by a certain date, and in return you will give me some money right now. If it doesn't reach that price by that date, then I keep my shares and your money."
That is the most simple way I can put it, but let me give you a detailed explanation, and then I will go over the pros and cons.
Imagine that you hold 500 shares of Company A that you bought for $10 / share. You spent a total of $5,000 and hope the stock will go up of course, but to make a little bit of extra money you look at the options:
Option 1
Another investor will pay you $0.20 per share if you agree to sell them the stock at $11 if it goes to $11 or more after exactly 30 days. That's $100 up front on your 500 shares no matter what, and if it is $11 or more exactly 30 days later (it doesn't matter what the price is on any day except for the exact day the option expires) then they will buy your shares for $11 / share.
So you earn:
$100 up front and
$500 gain on your investment if it goes to or above $11/share exactly 30 days later since you bought 500 shares at $10.
A grand total of $600 or a 12% return in 30 days! Not bad at all if you ask me.
OR
$100 up front and
you keep your 500 shares if it doesn't go to or above $11/share exactly 30 days later
So you've earned $100 and kept your shares and you can repeat the process.
Option 2
Another investor will pay you $0.10 per share if you agree to sell them the stock at $12 if it goes to $12 or more after exactly 30 days. That's $50 up front on your 500 shares no matter what, and if it is $12 or more exactly 30 days later (again, it doesn't matter what price it reaches before exactly 30 days) then they will buy your shares for $12 / share.
So you earn:
$50 up front and
$1000 gain on your investment if it goes to or above $12/share exactly 30 days later since you bought 500 shares at $10.
A grand total of $1050 or a 21% return in 30 days! Not bad at all if you ask me.
OR
$50 up front and
you keep your 500 shares if it doesn't go to or above $12/share exactly 30 days later
So you've earned $50 and kept your shares and you can repeat the process.
So What's The Best Strategy?
Well, it really depends on how high you believe the stock you own will go in a certain period of time. It's a win-win scenario when you're bullish on a stock (but not always a winning move, which I will discuss in the cons section) because you can choose to do one of two things:
You can choose to sell an option that will have more of a chance to occur (option 1 in my example) as a way to earn a great return off a stock you're bullish on, but not too eager to hold on to indefinitely.
You can choose to sell an option that will have a low chance to occur (option 2 in my example) as a way to earn a little extra money from just holding the shares, and continue to hold the shares since you're bullish and believe they will go significantly higher in the future.
So once again, it really depends on what you want and what you think of the stock you own.
This Sounds Too Good, What's The Downside?
Yes it is too good to be all true, but there's a reason why I said this is a "safe" options trade. The downside includes the same downside with owning any stock: the stock could go down, or it could go down significantly.
In my example, imagine you were bullish on Company A and bought those 500 shares at $10 / share, only for it to go down to $8 / share. Sure you could have earned a little extra money on your option, but with all stock ownership there comes the risk of your share price going down.
There is another significant downside. Using the same example, let's assume we took Option 1 that we sell the shares if they go to $11 / share or more. Imagine Company A announces a huge deal with Company B and the share price skyrockets to $18 / share and continues to grow until the day your option expires. Unfortunately for you, you must sell your shares at $11 / share even though they are worth $18+ / share.
Now, in this scenario you still made a nice profit of 12%, but you lost your chance to make that 80% profit if you had not sold the option. So think of an option as selling your right to keep potential gains.
Cool, So How Do I Do This?
Your online brokerage account should be capable of this if you've registered for options trading. If you haven't, you can ask your financial institution to register you.
When you are online, you can view the different strike prices, which is the agreed sale price, and the exact date of which that sale could potentially occur. You can select different pre-determined dates (35 days, 63 days, 94 days, etc...) and different pre-determined prices ($11, $12, $13, etc...).
After selecting the date & strike price, if you own the shares you would like to sell the option for, select Sell To Open Covered. The quantity you would sell is counted in hundreds, so if you have 500 shares you can sell 5 options. You may not sell fractional options (to the best of my knowledge).
Lastly, best of luck to you all in your investments and I hope this helps enlighten you on how you can make a few extra bucks with your diversified portfolio!