Covered Call

One of the best-known options strategies, the covered call involves making money by selling call options on a stock you own. It’s a conservative strategy, and is not aimed at making a fortune but a regular 2% or 3% a month.

Because you own the shares, the call option is ‘covered’ — you’re covered if you need to supply the shares to the option buyer. But the intent is to repeatedly sell call options, selling another one when each expires worthless, and thus generate a regular income. As long as the share price does not rise to the option strike price, you keep the premium and still own the shares.

Note that you should only sell as many calls as the number of shares you own, remembering that each call is for 100 shares. Each call obliges you to sell 100 of your shares at the strike price, regardless of how high the current price has risen. This limits your potential upside, as you’ll never get more than the strike price, so you should preferably have a neutral to slightly bullish view of shares.

Though you have a choice of months and strike prices, the classic covered call is at the money at the soonest expiration. You want to collect a good premium from an option that expires quickly. An at the money strike price is worth more than out of the money, and you want to repeat this frequently. You could also write an in the money call — you can still profit from buying a stock at one price and selling an option for a lower price, because all call options are worth at least the intrinsic value plus some time value, so you will in total receive more than the value you are giving away.

Naked Put

Say you want to invest in some shares, but the price you want to pay is less than the current price. Instead of just waiting for the share price to drop to your level, why not sell a put at that strike price? The fact is that you were going to buy the shares at that price anyway, and when you sell the put you receive the premium.

The naked put — naked means you have no long or short position in the shares at the moment — must resolve in one of two ways. If the price of the shares drops below the strike price, you will be obliged to buy them at the strike price. You were going to do that anyway, so the fact that the price may be lower still doesn’t matter, you would have suffered that loss after buying them in the normal way.

If the price of the shares stays above the strike price, then you won’t get to own them yet, but you have profited by the premium paid. After expiration, you can sell another put, basically trying again to buy them at the price you want to pay.

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