Can some one please explain how call options, using shares you already own, work?

Question

Please describe the steps involved, and the costs, using an example.

I have heard they are quite a profitable way to trade and not very risky. Do you agree?

Answer 1

The strategy you are refering to is called writing covered calls. Basically, you write (sell) an option on a stock that you own. One options contract represents 100 shares. If you owned 500 shares of a stock, you could wirte 5 contracts. It is a way to generate income from stocks that aren't moving. The problem with this strategy is that you limit your upside potential. Stocks rarely move up in a straight line. They typically stagnate for long periods of time, with periodic spikes. With covered calls, you run the risk of missing the upside spikes (the upside potential was the reason you bought the stock to begin with).

The strategy work like this: Say I own 500 shares of AIG. AIG's stock price is currently $64. I don't think that we will get much movement for the rest of the month (options expire at the end of business on the third Friday on the month of the contract). I decide to write (5) Sept. 06, 65 calls for $.15 / contract. $75 ($.15 x 500) will be deposited in my account (minus commisions) from the sell of the options. If AIG's stock price ends below $65, I keep the proceeds and the stock. If the stock price ends the month above $65, the options will be excersized, and I will receive $65 / share for the stock (plus the options premium which is already in my account). Let's say AIG ends at $70 a month. Even though you are receiving an extra $1 / share above the stock price at the time you wrote the contract, you have missed out on $5 / share for a lousy $.15 premium.

I don't think covered call writing is a good strategy for most investors, because of the risk of missing out on great returns.

Answer 2

An earlier answerer covered part of your question. Let me address the risk/profit issue.

Covered calls are safe: you already own the stock and you get some income from selling the call.

You have 2 exposures: #1 - You forego potential upside if the stock you own goes up higher than the call. For example, let's say today you own 1000 shares of GM and the current market value is $37/share. Let's further say you sell 10 November '06 $45 calls and that you receive $1000 for the calls. (These are all made-up numbers to illustrate the point.) So long as GM does not go above $46, you come out ahead. If GM goes to $60 because, let's say Toyota buys them out, you do not get the full value of the appreciation to $60. You give up potential upside for having sold the call. Plus, if your shares are called away, that is a taxable event for you.

#2 - You reduce your flexibility. You have to hold on to the shares until the call expires, or you will likely want to buy back the call if you sell the shares. Let's say GM goes to $32 and you want to sell because you no longer want to own them. If you sell the stock and do nothing with the call, now you have a naked position on the call and your risk is much greater. You would probably want to buy back the call, which at that point would probably be woth less and would represent a short term gain for you.

Let's say instead GM went up to $42 and you would like to sell to capture the gain on your shares. Maybe you feel the stock is overvalued at $42 and don't want to hold it and see it go back down. You would want to buy back the call as well, and that call is probably now higher-priced than before. So again here, you give up some of your upside.


Writing covered options can be a good way to earn extra income, bu there are trade-offs as I have pouinted out.

Answer 3

They're called covered calls where you sell call options on the stock you own. If the stock goes up and the buyer exercises then you already have stock to deliver and don't have to buy on the open market. If the stock goes down and the option isn't exercised then you just made a profit for whatever amount you sold the opttion for.

Check out http://www.investopedia.com/terms/c/coveredcall.asp for more info

Answer 4

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Answer 5

perhaps you can try forex. which is also excellent way for you to invest.

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try forex from here:

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Good Luck && Wish you make a fortune!