By: Zachary Scheidt of Street Authority

The covered call strategy is a reliable way to generate income in your investment account on a monthly basis. Basically, this investment approach captures income by selling call option contracts, which speculators purchase in hopes that they will generate outsized returns as stock prices advance. By selling call options, we allow these speculators the chance to make large profits, while we collect high-probability income payments.

Here's how the covered call process works: We purchase shares of stock the same way a traditional investor would. We then sell call option contracts against these shares (one for every 100 shares that we own). Selling these contracts obligates us to sell our stock at the option's strike price, provided the market price is above this level before the option expires.

This approach puts a cap on our potential return because regardless of how high the stock trades, we will still be obligated to sell at the strike price. However, since we are receiving a payment from selling the call contract, known as a premium, this income is very reliable and gives us a much higher probability of a positive return on our investment. So the covered call approach sacrifices the potential for a very high return in exchange for a more stable, reliable income stream.

Choosing Which Call Option Contract to Use

Option contracts are available on a monthly (and in many cases, weekly) basis, giving us more choices in terms of which contracts we want to sell. Traditional call option contracts expire on the Saturday after the third Friday of each month.

When implementing a covered call trade in our account, we must choose an expiration date. Typically, the more time left until expiration, the higher the price will be for the call option. This is because the contract is more attractive to buyers, because a longer time horizon allows the stock more time to trade higher, giving the owner a greater chance to profit. From our perspective as call sellers, a higher price means that we receive more income from selling the contract. Continue reading "The Best Strategy For Reliable Income In A High-Risk Market" →