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COVERED
CALLS
for
INCOME
&
SAFETY

by MIKE SCANLIN

Covered Call Tutorial - Born To Sell
Whether you're an experienced covered call investor, or this is your rst time,
you've come to the right place. We at Born To Sell are passionate about two
things:
1. Covered call investing, and...
2. Making covered calls easy, less time-consuming, and more pro table by
providing the best trade selection and portfolio management tools available.
This tutorial will provide you with the basic knowledge, tools, and techniques you
need to understand covered call investing. But first, a fun fact:
Over 75% of all options held until expiration expire worthless.
That's why you should do what the pros do and SELL options to other
people. After all, if most of them will expire worthless, why not collect some
money for them today while they still have value? It's what you were BORN
to do!

Investing in covered calls is not a get-rich-quick strategy. It's an income-oriented
approach that anyone can do (and if you like receiving dividends, you'll love
receiving call premium each month). This free covered call tutorial contains
lessons that will teach you the advantages, risks, and rewards of covered call
investing.

Covered Call Tutorial - Born To Sell

Covered Call Writing
In order to write covered calls you will need:
1. A brokerage account (we do not handle cash or execute trades here). You
can also write covered calls in most retirement (e.g. IRA) accounts.
2. Permission to do covered call writing. Many brokerage accounts allow
writing of covered calls by default. If not, your broker has a simple form you
fill out in order to sell call options in your account.
3. 100 or more shares of stock, or enough cash to buy 100 shares. Ideally, for
diversi cation, you will have enough stock or cash so that you can own 100
shares of several different companies.
4. A high-quality trade selection and portfolio monitoring service (you're
here!).

Writing covered calls is a simple investment strategy you can do. It does not take
much time to learn, execute, or to follow the trades. Anyone can write covered
calls on stocks they own. It's the rst options trade most people learn when they
start trading options, and it's also the most popular options-based trading
strategy (4 out of 5 option investors write covered calls). Let's see how it's done...

Covered Call Writing

Long Stock vs. Short Option
Before we discuss covered calls, let's review the terms "long" and "short".
In investment lingo, you are long a security if you own the security. You
bought it, you own it, and you will pro t if it goes up in value. This is the
normal case for most investors. You buy 100 shares of XYZ stock, and now
you are long XYZ.
On the other hand, you are short a security if you have sold it without
owning it. Short sellers will buy the security back at a later date (i.e. they
cover their short position in the future by buying what they had previously
sold).

The reason you would short something (sell something you don't own) is because
you expect it to fall in value. You hope to buy it back at a later date for less than
you sold it for today.
For example, if you think ABC stock will decrease then you can sell 100 shares
(which you don't currently have). You receive cash from the sale today and are
now short 100 shares of ABC. Your brokerage statement will show -100
(negative 100) as the number of ABC shares you own. At some point you will
need to buy 100 shares of ABC to cover your short position.
Covered call investors do not short stock, but do short call options. It is the short
option that generates the income for a covered call investor. See next page...

Long Stock vs. Short Option

Call Option
There are two kinds of stock options: calls and puts.
A call option is a tradable security that gives the buyer of the call option the
right to buy stock at a certain price ("strike price") on or before a certain
date ("expiration date"). Likewise, the seller of a call option is obligated to
sell stock at a certain price by a certain date if the buyer chooses to exercise
his right.

For example, a "January 50 call option on ABC stock" gives the buyer of the call
option the right to pay $50/share for 100 shares of ABC stock any time between
now and January. If that buyer decides to exercise his right to buy the stock at
$50/share then the person who sold him the call option is obligated to sell 100
shares of ABC stock to him at $50/share.
The buyer and seller agree in advance on (1) the stock involved (called the
"underlying security" or "underlying"), (2) the duration of the option ("expiration
date"), (3) the exercise price ("strike price"), and (4) the price of the option. Like
stocks, there are many investors buying and selling options every day and each
has a bid and ask price quoted by the exchanges.
A put option is the opposite of a call option: it is the right to sell a stock at a
certain price by a certain date. Born To Sell is not concerned with put options
and will focus this tutorial on call options and covered calls.

Call Option

Covered Call Definition
A covered call is an investment strategy involving two transactions.
1. You buy stock (or use stock you already own).
2. You sell a call option against that stock.
The combination of being long the stock and short a call option is called
"covered call." It is also known as a " buy-write" transaction (because you
buy the stock and write (sell) the option).

Because 1 option controls 100 shares (we'll get to that in the next section), the
covered call definition can be expressed this way, too:
1 covered call = long 100 shares stock + short 1 call option

It's called "covered" because, as the seller of the option, if the call option is
exercised you already own the stock you need to ful ll your obligation to deliver
the 100 shares. There are no unbounded liabilities in a covered call situation.
It is worth mentioning that there is another kind of call option de nition: "naked"
(also known as "uncovered").
The de nition of a naked option is one where you have sold (shorted) the
option but do not own an offsetting position of the underlying stock.

Selling naked options is extremely risky and represents potentially unlimited
liability to the seller. It requires constant monitoring by the seller but even then a
sudden move can cause dramatic losses. It is the OPPOSITE of what covered call
writers do. We do not encourage or recommend running with scissors or naked
option writing; you could get seriously hurt!

Covered Call Definition

Options Explained
Having options explained to you doesn't have to be dif cult or confusing. If you
read the rst few pages of this tutorial you should get a good understanding of
how they work. First, some put and call option basics explained:

One option contract controls 100 shares of stock.
However, options are quoted on a per-share basis so when you see an option
price quoted at $1.50 that means it's $150 per option contract (because each
contract controls 100 shares).
If you owned 100 shares of stock, you could sell 1 call option against it and
receive $150.
If you owned 500 shares of stock, you could sell 5 call options against it (not
500 call options) and receive 5 x $150, or $750.
Likewise, if you own less than 100 shares of stock you can't create a covered
call position from it.

Options (calls and puts) have 3 attributes to identify them:
1. the underlying stock they represent
2. the expiration date
3. the strike (or exercise) price

Options Explained

Options Explained
Monthly options expire on the Saturday after the 3rd Friday of their expiration
month. No reason. They just do. The last day they trade is the day before they
expire (i.e. they stop trading on the 3rd Friday of the month).
Strike prices are generally available in $5 increments, or in $2.50 increments for
lower priced stocks, or in $10 increments for high priced stocks. Some heavily
traded stocks have strikes in $1 increments. (You don't need to remember this;
we'll show you all of the available choices in our tables; that's just the kind of topnotch firm we are.)
There are 398,233 call options available today with different combinations of
stock, month, and strike price, but for some stocks, some months, and some strike
prices, there are no options available. The Chicago Board Options Exchange
decides which options are available. You will see "-" in our tables if an option is
not available.
Another way to have call options explained when you're done with this tutorial is
to read through our covered call blog. It explains stock options with several
examples.

Options Explained

Option Exercise
In the physical world, exercise involves sweat, pain, and sometimes tears. Well,
we have those things in the option world, too. However "exercise" has a different
meaning...
In the option world, the buyer of a call option (not you... as a covered call
investor you are a seller of call options) has the right to buy your stock at a
certain price (strike price) by a certain date (expiration date). When he
decides he wants your stock at that price he will call his broker and exercise
his right to force you to sell your stock to him at the strike price.

Options can be exercised by the option buyer at any time on or before their
expiration date. The majority of options expire without being exercised at all.
Of the ones that are exercised, almost all are exercised on their expiration
date.
Sometimes an option is exercised before expiration, which is called early
exercise. Early exercise sometimes happens if the underlying stock is about
to pay a dividend (more on that in the ex-dividend section).

Option Exercise


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