Covered call options. Can some one give me the details please/?

Question

I want to start doing a few deals in covered call options, but I have no clue how it is done:

1) Do all brokers deal in them or only some specialist ones?
2) What is the jargon used in this business?
3) How do I place the order, ie what do I tell the broker?
4) How far ahead can I sell?
5) What are the typical charges
6) Can I sell any number of shares or in fixed lots?
7) How much will I receive if the share price goes down and the buyer does not buy? and when will I receive it?
8) What is the logic behind call options? ie why should any one undertake to pay a higher price in 3 months (say) when he can buy for less now?
9) Anything else I should know?

Answer 1

You're asking the right questions, but to answer them requires not just one book but several.

Borrow these books from your library. Browse Yahoo's big options website. Finance>investing>options. Visit the cboe (Chicago Board Options Exchange, the granddaddy of them all) website at cboe.com & study there.

All brokerage houses can deal in options, but, among individual broker representatives, many do not because the knowledge is too intricate. In addition, commissions at full-service brokers are so high as to be unbearable.

For these reasons nearly all options traders, sooner or later, wind up at online discount brokers.

The "jargon" vocabulary is vast. If you're going to play here, you'll have to learn the terms accurately. See the literature !

You've picked the right strategy for a beginning investor in options - a covered call write. It is the most conservative strategy and, coinciding as it does with this moment of record-high-indices in the US, if markets begin to fall off somewhat it would be the best approach of all.

In a covered call, the investor holds shares of common stock, called the "deliverable" or the "underlying." He sells, through a brokerage house, the right to call away his common stock at a fixed price (the "strike price") for a fixed period of time.

Each option contract represents 100 shares, so an investor must own at least 100 shares to be able to sell at least 1 contract. If he owns 573 shares, he will be able to sell only 5 call contracts.

There are options on thousands of companies in the USA. Their strikes and expiration dates, or series and classes, can be studied at the aforementioned cboe, at the amex website, the international stock exchange, the boston options exchange, the philadelphia exchange, at least one other. Many options are interlisted, with the most liquid ones trading on all exchanges simultaneously.

These websites all have introductory and advanced information materials, forums & workshops for investors. If you live in a big city, look for a free information lecture by a representative from one of these exchanges.

Turning now to your last questions, surely you can see why many are willing to buy call options ... they think share price will continue to climb ... they don't want to pay the full price for the stock itself ... so they purchase a call option expiring in 3-6 months for a fraction of the cost. In effect, they are gambling.

The price they pay is called the "premium." If stock declines instead of rising during lifespan of call option, they will lose 100% of their investment.

Countless studies show that these investors - the buyers of naked calls or puts - are the ones who lose money.

It is the sellers of calls & puts who make money, because they are selling "time value" which is built into the premium's price. Consider the call seller. He owns 100 shares of XYZ, a stock presently trading at 20.00. He sells a january 22.50 call option for 1.00 through his broker.

He gets to keep the $1. His shares can be called away from him at 22.50 anytime between now & 3rd friday of jan/07. However, before that date, our investor will be adjusting his position so as to, once more, sell time. And he'll keep doing that over years and years. He'll own the stock, he'll collect the dividends if company pays dividends, and he'll collect capital gains from the repeated sale of call options.

There are risks - but that's another chapter. If the stock melts down, he won't be happy. If stock melts up, he won't be happy.

Then there are puts, which are opposites of callsl. But that's another book.

Then there are combination or hedged strategies, of which the covered call is the plain vanilla variety. But the combination spreads are many chapters & books away. It also helps if you're really good at maths, since future pricing theory uses algebra.

You can see why full-commission retail broker representatives usually don't bother with options, they're just too intricate. Successful options traders tend to be independents or experienced investors with strong math skills who make their way to discount brokerages.

Whatever you do, please don't dream of signing up for one of these predatory "we've-got-100%-successful-trading-software" workshops. Typically they cost thousands of $$$$. They are ripoffs. Investigate them in the internet and you'll find many who paid the $$$$, only to be desperately disappointed. Nothing, absolutely nothing, can guarantee riskless profits.

Answer 2

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Answer 3

These questions are typical of a beginner; all the wrong ones, and you're getting advice from novices. These are all questions you can answer yourself at any learning site or beginning book on options. But you are too lazy to be successful, and would rather waste time typing a gazillion questions before you've even tried.

Your first question should be "is this feasible?" And related questions, what are the drawbacks, what is the risk/reward?

Most people spend untold months and even years going down this road with Options, and won't dump it because they've got so much time invested in it, and won't admit it is too intricate and daunting. So they remain "sophisticated" and "knowledgeable" and trade an option now and then.

But covered call writing is a waste of time. The only person you're making money for is the broker, by doubling or tripling your commissions. Here are the reasons:

1) If you own a stock and the price goes up, the last thing you want is to sell it when it first takes off. You cannot hit Home Runs this way. It defeats the whole purpose of buying the stock in the first place.

2) Some people actually think they are "potected" by writing the call. Okay, they guy that wrote the MCD call for $205 just protected himself for a two-pt move. Sir, that is not "protection," but rather one day's movement within a range.

There actually could be some times when it might be proper to sell a covered call, but nobody here keyed into those times. But those times are about as easy to call as whether the stock is going up or down.

The options game is for institutions and people with deep pockets and experts willing to devote their life to it. It is very advanced stuff that a novice can't even begin to perceive, and unless you're willing to devote your life to it ...

Answer 4

1) Do all brokers deal in them or only some specialist ones?

I only use Scottrade but I am sure most do.

2) What is the jargon used in this business?
Long story, you need to study more

3) How do I place the order, ie what do I tell the broker?
I use the internet to place a Limit order to "SELL TO OPEN" a call.

4) How far ahead can I sell?
You can sell a covered call only after you purchase a stock. You cannot sell your stock if you have sold a covered call on it, untill you either buy the call back to close it, or the call expires.

5) What are the typical charges
It varies, I think it is $7.00 + 1.50 per contract.

6) Can I sell any number of shares or in fixed lots?
1 contract is usually for the option to buy 100 shares, but in special case, such as a stock split that can vary.

7) How much will I receive if the share price goes down and the buyer does not buy? and when will I receive it?

Read on.

8) What is the logic behind call options? ie why should any one undertake to pay a higher price in 3 months (say) when he can buy for less now?

I bought 100 shares of McDonalds in April for $35 per share. The price went up to $36 per share shortly after. I sold a covered call for $2.05 per share, making $205. The call has a strike price of $40, and an expiration date of Jan 2007.

If the price is under $40 by the expiration, the call expires worthless and I get to keep the $205 and my MCD stock.

If the price is over $40 by the expiration, the stock sells automatically for $40, and I get to keep the $205 plus all the money from the sale of the stock at $40 per share. The buyer gets the stock, which is now worth over $40.

If the price drops to $32.95 per share, I have not lost any money, because I made $2.05 per share by selling the call. The call expires worthless on it's expiration date, and I can sell another covered call on my MCD stock.

If the price drops below that, I am not out as much as I would have been if I did not sell a covered call. And when the call expires, I can sell another one.

9) Anything else I should know?
Practice on paper for a year first.

Answer 5

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Answer 6

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Answer 7

you own the stock and your are selling (writing) a contract that gives the purchaser of that contract the right (but not the obligation) to buy the stock from you, for a certain period of time, at a set price (you have the obligation to deliver the stock).

All you need to do this is a margin account, virtually any broker can do this, or you can do it yourself with an online account.

The reason you do this is to generate income, but of course it limits your upside potential if your stock gets called away.

I believe both the CBOE and OCC have on-line tutorials, and good book on trading should explain this and the various strategies, as well as the investor eduction section of most major online brokers.

Hope this helps.

Answer 8

Covered call writing is an options strategy where the owner of a stock "rents" out his shares for a "fee".

You can sell covered call options that expire in a month, 2 month, 3 month, ..etc up to even 2 years.

Covered call is just one of the many strategies available in options trading. My recommendation is not to just stick to covered calls but to explore all the other strategies out there.

For more info on covered calls, check out this page: http://www.theoptionsguide.com/covered-call-writing.aspx

Answer 9

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Answer 10

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