COVERED CALLS

COVERED CALLS

In yesterday’s writing I discussed terms you need to be familiar with and one was “Covered Calls.” Today I will give you a simple explanation of a “Covered Call.”

I first learned of the covered call in my early trading days of 1998. I tried a few trades and found them to work, at least they worked for me. My strategy was to find good stocks, which were optionable and buy the stock of the dip, then wait for it to run up so I could write the call. Since I am primarily writing this for beginners I should not assume you know what I mean by, “buying on the dip.” Stock charts will show you stocks are almost never constant in their price. They are usually going up or down and sometimes sideways but they almost never remain constant. To buy on the dip is to make your purchase when the price “dips” down a little. In latter 1998 and early 1999 I was buying stocks like CPQ, SLM, BLS, to nama just a few. At that time CPQ was the symbol for Compaq, SLM was SallieMae, and BLS was Bell South. I normally bought at least 100 shares of a stock and tried to buy 1000. The reason I bought in these multiples was because hoping to write a covered call.

CONTRACTS
A contract is an agreement to purchase a block of options and covering a number of stocks for that company or equity. With a few exceptions, a contract is 100 shares of stock for 1 contract. If you are buying equities, you can buy in different multiples, even as few as 1 share. It would be a little foolish to buy only one share though because you have to pay a commission to the brokerage firm, then average this commission into the cost of your equity. With the brokerage firms I use, the commission is the same price if you buy one share, one hundred shares, or one thousand shares. The definition of an option is the right but not the obligation to buy the underlying equity at a given price within a given timeframe.

In my case I tried to purchase an equity close to but below the strike price of the option I was going to sell. I covered strike prices in yesterday’s blog. JAVAD, the symbol for Sun Microsystems is a stock I have traded since 1998. I like the company and have followed it extensively. (I am not recommending this stock, I am just using it as an example.) JAVAD today is trading at $19.84. My next step would be to decide from the brokers chart, which strike price I would sell. As you can see, this is just a little below a strike price of $20.00. If I bought the equity at $19.84 and sold the $20.00 strike price I would receive a premium of about .64 per share, which is also shown on the brokerage chart. This is found by first typing the symbol of the underlying equity then pressing “Quote,” on the brokers website. From the chart that comes up you would choose, (Option Chain.) The option chain is divided into two sections. The left side will be the call options and the right side will include the put options. This was also discussed yesterday. On this chart you will find the following information on both sides: SYMBOL, OPEN INTEREST, VOLUME, NET CHANGE, LAST (This is the last trade price), BID (This is the current bid for the option), ASK (This is the sellers asking price, or what they are willing to sell for). This option would expire in 24 days from today’s date. Now let us assume I own 1000 shares of JAVAD. If I wrote a covered call for 1000 shares of my JAVAD stock I would receive a check into my account for $640.00. In essence, I would be renting out my stock for the next 24 days and they would have an option to buy JAVAD at $20.00. After the expiration date, if my stock remains below $20 I will probably keep my stock and I can write another covered call, sell my stock, or just hold on to it. The choice is mine.

I hope this information was helpful. Comments are welcome. Kermit