{"id":31198,"date":"2012-07-27T17:50:46","date_gmt":"2012-07-27T21:50:46","guid":{"rendered":"http:\/\/countingpips.com\/forex-news\/2012\/07\/covered-call-options-earning-rent-on-your-shares\/"},"modified":"2012-07-27T17:50:46","modified_gmt":"2012-07-27T21:50:46","slug":"covered-call-options-earning-rent-on-your-shares","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex-news\/2012\/07\/27\/covered-call-options-earning-rent-on-your-shares\/","title":{"rendered":"Covered Call Options: Earning \u201cRent\u201d on Your Shares"},"content":{"rendered":"

Article by Investment U<\/a> <\/p>\n

Most investors think that when they buy shares of a company, the only thing they can do is hold onto them in the hopes of generating a profit.<\/p>\n

But in a volatile market environment like today, writing – or selling – covered call options are giving many shareholders the chance to generate even higher returns by \u201crenting out\u201d the shares they own to speculative investors in exchange for monthly income.<\/p>\n

It sounds crazy, but it\u2019s absolutely true. And today I\u2019d like to show you exactly how it works.<\/p>\n

Like Renting Out Real Estate<\/strong><\/h2>\n

It may seem complicated at first, but writing a covered call option is like renting out a home with the option to buy.<\/p>\n

The way these leases work, tenants agree to pay a certain amount of rent each month to a homeowner for a certain period of time.<\/p>\n

At the end of that time period, the renter then has the option to buy the home from the property owner.<\/p>\n

When you write a covered call option, you\u2019re basically doing the same thing.<\/p>\n

As the \u201cshare landlord\u201d in this case, you already own the shares of the stock you\u2019re \u201crenting out.\u201d<\/p>\n

The buyer of the option would pay you a premium (or the rent) for the right to become the new owner of your shares if that stock hits, or rises above, a certain price (strike price) by a specified date (expiration date).<\/p>\n

The concept is really that simple.<\/p>\n

In fact, many investors today get their feet in the options market trading covered call options because, while there is risk involved, most of it comes from owning the stock – not selling the call.<\/p>\n

Let\u2019s look at a few examples. Just keep in mind though, one options contract represents 100 shares. So you\u2019ll need at least that many to use this strategy.<\/p>\n

Covered Call Scenario #1: Shares Become \u201cin-the-Money\u201d<\/strong><\/h2>\n

If you\u2019re really bullish on a stock for the in the short term, writing covered call options is probably not a good strategy.<\/p>\n

That\u2019s because if the stock price becomes \u201cin-the-money\u201d – that\u2019s when shares rise above the strike price by the expiration date – your call option will be exercised and you\u2019ll be obligated to sell each option, 100 shares per contract, to the buyer.<\/p>\n

The bad news here is if the stock continues to climb higher, you\u2019re going to miss out on any of the extra gains that come after shares hit the strike price.<\/p>\n

However, on the bright side, you will still make a profit from the stock price rising. It just won\u2019t be as much as if you simply held onto the shares from the very beginning.<\/p>\n

Another plus, you\u2019ll be able to keep the premium that the buyer paid you, which will add to your returns.<\/p>\n

As you can see below, by writing the covered call (the bold line), you\u2019re limiting the upside. As once the stock hits the strike price, the options buyer will likely exercise the option and take your shares. However, you get to keep the premiums and capital gains you collected up to that point.<\/p>\n

\"Covered<\/p>\n

(Source: www.theoptionsguide.com)<\/p>\n

Of course, this is just one example.<\/p>\n

Covered Call Scenario #2: Shares Go Down<\/strong><\/h2>\n

Remember, when you write a covered call option, you have to own the shares of the company upfront.<\/p>\n

That\u2019s why, in this second scenario, two things will happen when the stock price goes down by the time your covered call option expires.<\/p>\n

One, you\u2019ll lose money because the value of the stock went down.<\/p>\n

But number two, you\u2019ll offset your losses somewhat because you get to keep the premium for selling the option.<\/p>\n

Here\u2019s where things can go really well though\u2026<\/p>\n

Covered Call Scenario #3: Shares Go Up, But Stay \u201cOut-of-the-Money\u201d<\/strong><\/h2>\n

For covered call sellers, this is the ideal scenario.<\/p>\n

That\u2019s because the call option you sold will be \u201cout-of-the-money\u201d – that\u2019s when the option expires worthless since the stock never actually hit the strike price – and, therefore, you won\u2019t be obligated to let go of your shares.<\/p>\n

An added benefit here is you\u2019ll still make money from the price increase of the stock. In addition, you\u2019ll also make extra money on the premium from selling the option.<\/p>\n

It\u2019s really a win-win-win situation.<\/p>\n

Studies have even shown that the return on investment from writing covered call options of U.S. stocks typically ranges anywhere from 3% to 9% per month.<\/p>\n

In today\u2019s market environment, this basic options strategy may be a useful tool for investors – willing to take on some risk – to bump their returns even higher, without risking everything they have.<\/p>\n

Good Investing,<\/p>\n

Mike<\/p>\n

P.S.<\/strong> As the seller, a general rule of thumb, think about 2% of the stock value as an acceptable premium to offer. You may also want to consider 30 to 45 days in the future as a good expiration date to start out with. Remember, with options, the further out in time you go, the harder it is to predict which direction a stock will head \u2013 but you\u2019ll also be able to charge a higher premium because of the time-value of money.<\/p>\n

P.P.S.<\/strong> Don\u2019t forget to consult your broker and do your own additional research before writing covered call options. Also, check out The Investment U Bookstore<\/a><\/em>\u00a0for some great resources to get you started in the options market.<\/p>\n

\n<\/a> <\/a> <\/a> <\/a> <\/a>\n<\/div>\n

<\/p>\n

Article by Investment U<\/a> <\/p>\n","protected":false},"excerpt":{"rendered":"

Article by Investment U Most investors think that when they buy shares of a company, the only thing they can do is hold onto them in the hopes of generating a profit. But in a volatile market environment like today, writing – or selling – covered call options are giving many shareholders the chance to … <\/p>\n

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