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Selling Covered Calls - The super short course.

Selling covered calls is the coolest thing since sliced bread. A broker explained that investors find it difficult to grasp the concept and many brokers are reluctant to take the time to explain the theory to their customers. In some instances, brokers do not make a commission off of calls you sell.

Here's the gist of it in a nutshell: Say you own 1000 shares of ABC that are currently selling for $50/share. Today is July 8 and you sell 10 August 55 calls for 2 points. Broken down this means you're offering to sell all your shares (10 lots of 100 shares each) on the 3rd Friday in August if the price meets or exceeds $55. The buyer of your call gives you $2000 today (2 points x 1000 shares). They will pay the 2K and hope the stock gets higher than 55 by the deadline. Here are the possible outcomes.

1. The stock goes up to 54 7/8 by close of market on the 3rd Friday. You keep the 2K and the shares of ABC.

2. The stock goes down to say 48 by the call date, you still keep the 2K and your losses are basically covered.

3. The stock closes at 55 on the call date. The entity that bought your call has the option to buy your shares at 55 or forget the deal altogether. You still keep the 2K.

4. The stock climbs to 58, the buyer exercises his call, buys your shares at 55 (a deal for him), but you keep the 2K and still get to realize the 5 point increase when your shares are sold.

Anyway you look at it you get to keep the money you received from selling the call. This is almost unbelievable. Call days are always the 3rd Friday of some month. Covered means you own the stock - it's really risky to sell "naked" calls on stocks you don't actually own.

Actual Example:

We sold a July 55 call of 900 shares of Winn Dixie on July 8 for 1 1/16 points. Our account was credited $956.25 - instantly. Winn Dixie was trading at 49 3/16 at the time. The chances of Winn Dixie going up 5 13/16 in 16 days seemed pretty slim. It never did.

Any of the above four scenarios could have occurred - but pretty much either way you would come out a winner. We kept the stock and the $956.25. Had we been forced to sell and being partial to Winn Dixie, we would have just waited for a down day in the market and bought it back.

Market Related Links

www.yahoo.com - track multiple portfolios complete with charts, news, and financial information (20 minute delay)

www.ipocentral.com - an excellent source of information on past and upcoming IPO's

www.agentsoft.com - real-time quotes, a must for stocks you plan to hold short-term

www.freerealtime.com - another source of real-time quotes

www.redherring.com - insightful investment commentary

www.fool.com - The Motley Fool. Who are those guys? The Butch Cassidy and Sundance Kid of investing.