The Basics of Covered Calls
The main idea behind covered calls is an investor writes call options (or call contracts) for a specific asset (stock or exchange traded fund) in order to generate increased income from that asset. For each of the covered calls written, an investor must own one hundred shares of the security. The process through which the profit is generated is pretty simple and straight forward: The investor gets paid a premium for each call option sold.
Covered calls are widely regarded as being a conservative and safe option strategy for investors that has a high potential for profit. However, this does not mean that covered calls can be regarded as without risk and this strategy, like all investment strategies, should only be used by investors understand the risks.
The main advantage for using covered calls is the investor immediately receives the premium for each covered call they sell. From a financial standpoint, covered calls are a viable solution for increasing the income generated by a long-term investment. But there are also risks associated with covered calls and any investor needs to understand them thoroughly in order to reduce losses and maximize their profits.
The most important risk for those using this financial solution is a significant drop in the price of the shares. A small decline in share price can be covered by investors through the premiums collected for each one of the covered calls sold, but investors need to be prepared for a more serious deterioration of the stock price. Another risk which is generally considered to be a negative to using covered calls is the fact that by utilizing this technique investors are limiting the upside potential of their stock. The potential capital gains cannot follow the ascending price of the stock above the strike price for each of the covered calls sold.
In cases where an investor’s stock experiences unprecedented price gains, some investors decide to increase their chances for profit by re-purchasing their covered calls. There are risks related to this tactic (called ‘rolling’) as the stock price might drop below the current level, thus leaving the investor with a loss.
A covered call screener is a powerful weapon in the arsenal of every investor as it allows them to drastically reduce the time that is generally reserved for trying to find high premium trades. After considering all the benefits related to using a covered call screener, we find that the need for a certain amount of research is still necessary. Investors should be careful when selling covered calls near earnings release dates or ex-dividend dates, as these can be volatile dates. In general, earnings released dates before option expiration should be avoided, while ex-dividend dates before option expiration should be sought after.
Keep in mind that the present article offers a very basic insight into the covered call screener and this financial tactic and that in order to get a better overview on cover calls and the best ways to use them you will need to do consistent research.
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