One of my favorite investment strategies is the covered call. This is a strategy that has you buy a stock and SELL a call option against it. Like anything you sell when you do it you receive money. Essentially with this strategy you are getting paid to sell a position you own at a specified price. For example one stock I personally own and do this with is T2 Biosystems (TTOO). TTOO closed yesterday at $1.87, they did report earnings yesterday so how the stock reacts to that is yet to be seen so if you were to look after i post it the price may be significantly different. Higher or lower who knows. I think at this price there is little downside but i am not a stock analyst. I like their main product. But for the purpose of explaining this i;m going to say the stock is 1.87 which is yesterdays closing price. Now below is what the option chain looks like for September
|Last Price||Change||% Change||Volume||Open Interest||Strike||Last Price||Change||% Change||Volume||Open Interest|
Now an option is nothing more than a contract to buy or sell something at a specified price - called the strike price- and on a specific day. In this case these options expire September 18. The left side are call options and the right side are put options. For the purpose of this we only need the left side.
Now looking at the 2.50 strike price if we look to the left we see 0.47. That means the 2.50 call option is 47 cents. Now an option is actually a contract to buy or sell 100 shares so you must multiply the 0.47 by 100 to see what you will pay or get paid for it. So 0.47 x 100 = $47.
Now with a covered call what youre doing is BUYING the stock and SELLING a call option. So lets say you like TTOO. You go out and BUY 100 shares, you then Sell a 2.50 call option on it for .47. So you paid $187 for the stock BUT you got $47 back by agreeing to sell it at 2.50 on September 18. Now if the stock is below $2.50 on September 18 you simply keep the $47. If the stock is above $2.50 it will be "called away" you still get the $47, you will have also made $63 on the shares you bought as well (2.50 -1.87 you paid for the shares). So the $63 + 47 = $110 and that would be your profit on your $187 dollar investment which is about 58%.
The critics of this strategy will tell you its bad because it caps your upside. Meaning i'm agreeing to sell at 2.50 but the stock could be $3 or $4 or $10 by the expiration date and that is true. But if the stock starts to run I can always buy more shares and I take profits along the way with every stock i own anyway so i'm ok with that. But my actual hope is that the stock stays below the $2.50 by the expiration date and I collect what i sold the option contract for and i get to do again next month.
For instance I own 2000 shares of it. Earleir this month I sold 20 $2.50 call options for 0.20. So i got $400 for that. Now if the stock is below $2.50 i keep the $400 and i'll look to do it again in September. If the stock is above $2.50 and it gets called away personally i dont care. I still made a great profit and that was the risk going in. Im not that worried about risk when im making money im worried about it when i lose money. And you dont have to sell them on your entire postion. For instance I have 2000 shares, i could sell 10 call options and still keep half my position in case it runs. It allows you to collect some money and lowers your cost basis and thus lessening your risk. Theyre a great way to get paid to own a stock in my opinion.