stock moves up then great you make money. But, what if the stock stays flat or even drops. You are out of luck and need to wait until the stock recovers to breakeven. This is risky as the only way you profit is if the stock increases in value.

Now, if you were to sell a covered call against that stock position you collect a premium at the time o

Covered calls are perhaps one of the most well known option trading strategies with investors. However, despite the awareness by many this is just a fraction of the total investors who fully know how to utilize them correctly. Let us take a step-by-step approach to help you better understand the advantages of covered calls.

What is a covered call?

Covered calls is an option strategy which consists of the selling of an option which is covered by stock in which you own. The option is sold at a strike price which is due to expire at a future date. For providing this option you in turn receive a premium (cash deposited in your account) which is yours to keep regardless of what the stock does.

What happens at expiration?

At expiration the covered call you sold will either be called out or expire worthless. If the stock price is higher than the strike price of the call option sold then the stock will be called away from you at that price regardless of what the stock price is. If however the stock price is below the strike price sold then that call option has expired worthless and you can sell another call to collect more money off that stock in your portfolio.

How does this protect my stocks?

This is where there is a lot of misunderstanding in terms of risk. When you buy a stock you are looking for the value of that stock to increase. Now, if the stock moves up then great you make money. But, what if the stock stays flat or even drops. You are out of luck and need to wait until the stock recovers to breakeven. This is risky as the only way you profit is if the stock increases in value.

Now, if you were to sell a covered call against that stock position you collect a premium at the time of

call?

Covered calls is an option strategy which consists of the selling of an option which is covered by stock in which you own. The option is sold at a strike price which is due to expire at a future date. For providing this option you in turn receive a premium (cash deposited in your account) which is yours to keep regardless of what the stock does.

What happens at expiration?

At expiration the covered call you sold will either be called out or expire worthless. If the stock price is higher than the strike price of the call option sold then the stock will be called away from you at that price regardless of what the stock price is. If however the stock price is below the strike price sold then that call option has expired worthless and you can sell another call to collect more money off that stock in your portfolio.

How does this protect my stocks?

This is where there is a lot of misunderstanding in terms of risk. When you buy a stock you are looking for the value of that stock to increase. Now, if the stock moves up then great you make money. But, what if the stock stays flat or even drops. You are out of luck and need to wait until the stock recovers to breakeven. This is risky as the only way you profit is if the stock increases in value.

Now, if you were to sell a covered call against that stock position you collect a premium at the time o

stock does.

What happens at expiration?

At expiration the covered call you sold will either be called out or expire worthless. If the stock price is higher than the strike price of the call option sold then the stock will be called away from you at that price regardless of what the stock price is. If however the stock price is below the strike price sold then that call option has expired worthless and you can sell another call to collect more money off that stock in your portfolio.

How does this protect my stocks?

This is where there is a lot of misunderstanding in terms of risk. When you buy a stock you are looking for the value of that stock to increase. Now, if the stock moves up then great you make money. But, what if the stock stays flat or even drops. You are out of luck and need to wait until the stock recovers to breakeven. This is risky as the only way you profit is if the stock increases in value.

Now, if you were to sell a covered call against that stock position you collect a premium at the time o

strike price sold then that call option has expired worthless and you can sell another call to collect more money off that stock in your portfolio.

How does this protect my stocks?

This is where there is a lot of misunderstanding in terms of risk. When you buy a stock you are looking for the value of that stock to increase. Now, if the stock moves up then great you make money. But, what if the stock stays flat or even drops. You are out of luck and need to wait until the stock recovers to breakeven. This is risky as the only way you profit is if the stock increases in value.

Now, if you were to sell a covered call against that stock position you collect a premium at the time o

stock moves up then great you make money. But, what if the stock stays flat or even drops. You are out of luck and need to wait until the stock recovers to breakeven. This is risky as the only way you profit is if the stock increases in value.

Now, if you were to sell a covered call against that stock position you collect a premium at the time of that sale which puts cash in your account. That premium in fact reduces your basis or should we say investment in the stock. In other words, you have protected your stock investment by the amount you collected from selling the short covered call. For example, if you sold a call option for $1.00 and purchased the stock for $15.00, you would now have a basis of $14.00 in the stock. Therefore, if the stock drops to $14.50 you are still ahead by $0.50 compared to if you did not sell that covered call option at all.

See where the advantage is? Someone who did not sell a covered call on that same stock is stuck with a loss and you are sitting on a gain. Now where do you think the risk is? A stock with no option sold would be my selection.

There has to be a downside...what is it?

The downside is that with traditional stock based covered calls you are limiting your gains because if the stock makes a quick move up above the strike price sold at expiration of that option you will not be able to realize any of that profit. So, its really a trade off....you are protecting yourself to a degree but have to be willing to give up some of the upside profit potential. Now, that being said, you can sell higher strike covered calls so you are able to gain more from the stock value if it move ups.

Covered calls are a useful tool to traders but there is a right and wrong way of doing thi