Covered calls are a great way to generate dependable cash flow from a bear market. Done right, this can add extra income to your brokerage account each and every Friday.
Below is a simple explanation of how you can earn money from falling stock prices.
What Is A Covered Call?
When you make a covered call, you are betting that a certain stock will not reach or exceed a pre-determined price on or before a specific day.
This may sound confusing, so here’s a real-world example.
As I’m writing this, Coca-Cola is trading at $61.45.
Selling a $64 Coca-Cola covered call that expires next Friday (June 17th) would pay you $0.10 per share.
Covered call contracts require 100 shares of a company as collateral. So your $0.10 / share premium would actually equal $10 total.
If you had 100 shares of Coca-Cola and sold one June 17th $64 covered call contract at $0.10, you’d instantly collect your $10 premium payment. And if Coca-Cola closed under $64 on the 17th, you’d keep your 100 shares as well.
However, if Coca-Cola closed above $64, your shares would be sold off.
You’d collect $64 per share, what the options contract agreed upon, but you’d have to buy your Coca-Cola shares back if you wanted to keep them.
My Covered Call Strategy (With Examples)
As you can see, there is some risk to selling covered calls. You don’t want to price your contracts too low, or sell into a surging bull market.
My personal strategy is to sell covered call contracts around the middle of the week, after I’ve gaged what the general market is like. I also like to pick a strike price at least 10% above the current share value. This helps reduce any risk of a surprise bull-run.
This week, I sold two covered calls. One for Altria, after the stock plummeted on bad news, and one for Archer-Daniels-Midland Company when it was clear the stock wouldn’t rally much.