After a 24% rally in the S&P 500 so far this year, stocks have seen rising volatility and have encountered some selling pressure in the last few days.
Earnings season has minted some big winners, especially among growth stocks, but we’ve also seen an increase in volatility measures, like the VIX, which contributes to higher prices when you’re buying or selling options.
If you’re long-term bullish on a position that isn’t showing a ton of momentum lately, you may want to sell covered calls to make more money on existing positions.
The risk of covered calls is sacrificing some of your upside potential to put immediate cash in your pocket, but if you’re neutral on a position in the near term, the rising levels of volatility in the market are juicing premiums for call sellers. Keep in mind, this is still a net bullish trade, so if you’re bearish on a stock, a covered call strategy isn’t ideal to repair a broken position. Cutting bait may be the better option there.
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How to Sell Covered Calls to Make Money on Stocks You Own
A covered call is a strategy that consists of owning an underlying stock and selling an option against the stock. Since a call option represents 100 shares of the underlying stock, you can sell one call against each 100 shares of stock you own. Because you own the stock, your short call position is “covered” by the stock.
A short option position by itself (without the stock) is very risky and requires a substantial margin balance.
A short call on a stock you own, on the other hand, is a very conservative strategy that requires no margin.
I would recommend a covered call options strategy against virtually any stock an investor holds. In my mind, it’s free money, and best of all, it’s a great way to start learning about options and options trading.
Let’s dive a bit deeper into how to sell covered calls with a stock that’s recently been trading sideways.
Had I bought 100 shares of Microsoft (MSFT) a month ago, after 30 days I would be down 0.9%. That’s certainly not a meaningful loss, but it’s also not helping the portfolio much.
However, with MSFT trading at 415, if I sold a December 20, 420 call for $8.65 against my stock holding (which is actually $865), my yield could be 2.1% if MSFT has another month like the one it just had and the calls expire worthless.
The downside to this strategy is by selling a call against my stock holdings, if MSFT exploded higher, I would not participate in the large stock gains, as the buyer of the call would have exercised his right to buy the stock from me. In the case of MSFT, I would make money until the stock traded above 420; however, above 420 my profits would be capped.
The net result is that I would outperform by selling a call if MSFT closes up to 428.65 on expiration (because of the $8.65 premium received), but would underperform if MSFT traded above that.
I’d also outperform should shares fall, because the covered call would offset a portion of my losses.
This is the exact strategy we use at Cabot Profit Booster, where we sell covered calls on Mike Cintolo’s weekly Cabot Top Ten Trader stock picks, which are 10 of the week’s strongest momentum stocks. We are looking to buy the best-looking stocks, as chosen by Mike, and then sell covered calls against those stocks to rack up yields ranging from 3-20% month after month.
If those sound like the kinds of monthly returns you’d be interested in – or if you simply want to learn more about covered calls or options trading in general – click here to become a Cabot Profit Booster subscriber.
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*This post is periodically updated to reflect market conditions.
