How can you make money in a down or sideways market, with minimal risk? Covered call option writing may be the perfect strategy for the conservative investor.
Here's how it works: A call option gives the holder the right, but not the obligation, to buy a stock at a set price by a certain date.
For example, I could purchase one contract of the August $22 call options on Kinross Gold Corp.
, which gives me the right to buy 100 shares of Kinross for $22 each on the third Friday in August (North American stock option contracts expire after the close of trade on the third Friday of the month).
If Kinross is trading at $20 today, and I buy the option for $1, and the stock closes at $25 in August, I can exercise my call option and buy the stock for $22, and then immediately resell it for $25, for a profit of $3, less the $1 I paid for the option, for a profit of $2 before commissions.
What if Kinross is trading at $22 or less when the option expires? Then my option is worthless, since there is no point in me buying a stock for more than it's worth.
And that's the problem with options.
Most options expire worthless, so if you buy them, you can lose everything.
It's high risk, and not for the conservative investor.
But here's another strategy.
Let's assume I already own Kinross, and it's trading for $21 today, and I want to lock in my profits.
I could sell the $22 call option for $1.
I still own the stock, and now I have $1 in my pocket.
If the stock goes up to $25 it will be called away, and I will have to sell if for $22.
But, I keep the $1 premium, plus I made $1 on the sale of the stock, so I'm up $2.
If I hadn't sold the option I could have sold the stock for $25 so I would have made $4, so I reduced my profit by selling the option, but I also reduced my risk.
If Kinross is trading at $21.
99 on the option expiry date the options expire worthless, and I keep the $1 premium and my stock, so my total profit is $1.
99.
I increased my profit by $1 by selling the call option.
Covered call option writing works best if you expect some movement in the underlying stock, but not a hugh amount of movement.
If you expect the stock to crash, sell it.
If you expect it to double in value next month, buy the call options.
But if you expect it to stay where it is or increase or decrease slightly in value, covering the stock by selling call options may be the best strategy for you.
Here's how it works: A call option gives the holder the right, but not the obligation, to buy a stock at a set price by a certain date.
For example, I could purchase one contract of the August $22 call options on Kinross Gold Corp.
, which gives me the right to buy 100 shares of Kinross for $22 each on the third Friday in August (North American stock option contracts expire after the close of trade on the third Friday of the month).
If Kinross is trading at $20 today, and I buy the option for $1, and the stock closes at $25 in August, I can exercise my call option and buy the stock for $22, and then immediately resell it for $25, for a profit of $3, less the $1 I paid for the option, for a profit of $2 before commissions.
What if Kinross is trading at $22 or less when the option expires? Then my option is worthless, since there is no point in me buying a stock for more than it's worth.
And that's the problem with options.
Most options expire worthless, so if you buy them, you can lose everything.
It's high risk, and not for the conservative investor.
But here's another strategy.
Let's assume I already own Kinross, and it's trading for $21 today, and I want to lock in my profits.
I could sell the $22 call option for $1.
I still own the stock, and now I have $1 in my pocket.
If the stock goes up to $25 it will be called away, and I will have to sell if for $22.
But, I keep the $1 premium, plus I made $1 on the sale of the stock, so I'm up $2.
If I hadn't sold the option I could have sold the stock for $25 so I would have made $4, so I reduced my profit by selling the option, but I also reduced my risk.
If Kinross is trading at $21.
99 on the option expiry date the options expire worthless, and I keep the $1 premium and my stock, so my total profit is $1.
99.
I increased my profit by $1 by selling the call option.
Covered call option writing works best if you expect some movement in the underlying stock, but not a hugh amount of movement.
If you expect the stock to crash, sell it.
If you expect it to double in value next month, buy the call options.
But if you expect it to stay where it is or increase or decrease slightly in value, covering the stock by selling call options may be the best strategy for you.
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