Got a question this week regarding options, how complicated they are, and if anyone can do them. The simple answer is yes they can be complicated and yes anyone can do them. However with call options there really is no complication and frankly they are very safe income strategy that anyone can do. In this posting I will explain call options, how you can use them, and give an example.
Options are no more than stock insurance. On the options market each trading day anyone can buy and sell options on stocks and other investment instruments. Options are intended to take some of the risk out of owning securities, but they also can make companies honest in their dealings with shareholders due to a strategy called short selling. Investors or traders are allowed to buy and sell certain options depending on the risk involved and are assigned levels of allowed trading based on experience and size of account. You can have millions of dollars and have no experience in certain options and you will not get approval to trade. The levels run from level one to level five. Level five in my opinion involves suicide traders since the options allowed there are asking for suicide if you trade them. I personally am allowed level four trading. Covered calls are assigned level one and frankly with minimal paperwork anyone can be assigned this level of trading.
Covered calls work like this. You own a stock and the stock has options. Almost every stock has options and you can find options where you find stock quotes. Usually somewhere on a sidebar. Yahoo is an excellent place to find option quotes and you can find them on the right hand bar third listing down. When you click on the options link you get call options and put options by expiration month. In this case we are looking at call options. So once you select call options you decide which month you want to take a option position. Usually they have a couple of up front months and then some out months sometimes going out a a year or more. The further you go out the more premium you get for the option. Premium is the amount you get if you sell a call option.
For this example let's use a very familiar and stock that is held by lots of people, Johnson and Johnson, symbol JNJ. As of the moment I am writing this JNJ is trading at $66.49. Let's also say you hold 500 shares. It does not matter what you paid for the stock as you can write a call option if you have a gain or loss in the stock. So a JNJ call option for $67.50 can be sold for 80 cents per share at this point which expires on the third Friday in July. So 80 cents per share for 500 shares equals $400 less commission. Using Scottrade, and I am not endorsing Scottrade just using their price, the price is $7 plus $1.25 per contract. Each 100 shares is a considered a contract and you must trade in lots of 100 shares for options. So the commission cost is $13.25 and you net $386.75 for the trade. Now if the stock does not go above $67.50 before the thrid Friday in July you keep your stock and keep the premium. If the stock trades over $67.50 anytime before the expiration date the holder of the option can "call" the stock from you. The person does pay you $67.50 for the stock, but anything over that price is the option holder's profit. The cost of selling your stock at Scottrade would be $7.00 so you would clear the $33750 for the 500 shares less $7. Note that you get to keep the profit between the $66.49 price of the stock when you sold the option and the $67.50 the option holder paid you.
Selling covered calls is called "writing" an option and as you can see call options are simply a way to increase your income on any stock you own. Once expiration date has arrived and the stock is not called away you can write another call option on the same shares. Doing this over and over again can make some nice premiums on your holdings. It has been years since I actually sold a stock, usually it gets called away from me after I have wrote an option. I call it letting someone pay my commission out of a stock. One other note, a smart play is anytime you buy a stock is to immediately write a call option out a few dollars and a month or two on the stock. That immediately lowers our cost basis and begins the process of making money on your investment.
This strategy works well in a market that is flat and trending up and of course it helps if you have a profit position in the stock so as not to lose any money. But even if none of these condition exist you can write options on stock far enough out time wise to most times not lose money and make some option premium. So go sign up for call options trading and make some extra money on your holdings. If you have questions e-mail and ask.
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