Prices of securities can go up and down in a matter of days. The volatility of prices is one of the main motivations for traders to engage in covered calls. By writing covered call options, a trader sells the rights to a security, such as a stock, for an agreed price (also known as a strike price) at a predetermined date. In return, the trader is paid for it with a fee that is called a premium. However, the premium also means that the buyer can own the stock in the future if he or she exercises the option. This usually happens when the price of the stock becomes higher than its strike price. Like all other investment strategies, covered call transactions have fees with commissions for the individual that sells the call, as well as the individual that purchases the stocks.
Traders who write calls not only want to gain extra income from the premiums, but they also hope to keep their securities. They hope that the price of the stock will remain lower than the strike price. This means the option buyer will not be encouraged to proceed with the option. When the covered call option expires worthless, the seller gets to keep both the premium and the stock shares.
Most of the traders who opt for covered call writing don’t want to lose the shares of stocks they own. They feel that the value of stocks they own won’t increase significantly in the future, especially on or before the call option expiration date. If the price of the stock they wrote a covered call for suddenly goes up, then there’s a big possibility that the option buyer will exercise the option, thus meaning the call option writer lose his shares.
The risk of entering a covered call option is that the call writer may not only lose the shares of stocks but also a great income opportunity in case the stock value suddenly increases. If the stock’s price goes through the roof, then the option buyer will naturally exercise the option. This means the seller will lose his shares, as well as an opportunity to gain more by selling the shares.
Covered calls can be a very strategic investment move for any trader, but just like any other investment move, traders have to study their options before entering into a covered call options agreement. A screener may help improve traders’ chances. Sign up for a free trial for a call screener at barchart.com.
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A covered calls strategy is a limited risk strategy that is utilized by veteran and beginner traders, alike. It provides excellent benefits to both the buyer and the seller of the stock. Basically, covered call options provide buyers the opportunity to buy a stock at a predetermined price on or before a preset date. The buyer is not obligated to buy the stock once the option expiration lapses, especially if the stock price goes even further in the future. However, he or she can buy the stock if the prices continue to rise, which makes the arrangement a great investment considering the buyer bought the stock at a lower price.
Stockholders who enter into covered call contracts have various reasons to do so. For starters, these stockholders want to earn extra income from the premium that occurs when another trader enters into a covered call contract with them. The stockholders often believe that the prices of the stocks they are holding won’t change significantly in the near future, so the best way for them to maximize their earning potential is to create a covered call agreement. Aside from generating extra income from the premium, the stockholder who sells a stock in a covered call arrangement has the opportunity to keep the stock if the buyer does not proceed with the purchase of the stock once the option expiration lapses.
However, stockholders who enter into covered call contracts are also suppressing the value of their stocks. These stockholders are risking the probability that the stocks they own will become more valuable in the future. For instance, if a stockholder who sells a stock for a strike price of $40 is basically saying the said stock’s price won’t be more than $40 after the expiration, thus he could lose out on additional money in case the price rises to $45 or higher after the deal expires.
On the other hand, traders and investors who enter into covered call contracts usually believe that the stocks they are interested in will increase in value after the option expiration lapses. These traders are no fortunetellers, but they usually foresee the stocks they are acquiring through a covered call arrangement will shoot up in prices in the future.
Entering into covered call options is one of the many investment strategies that equity traders employ. New investors who want to know more about covered calls can find more information at barchart.com, a leading financial market information provider.
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