Covered calls is a strategy where you make money from the premium given with an options contract. In the UK, this means buying a financial product such as stocks and then selling a related option with it as well. A covered call serves to maximize return on investment by generating additional income from these securities while still allowing for capital appreciation.
This type of investing strategy increases risks slightly because there is no way to mitigate this exposure until the options expire. Still, it dramatically reduces exposure to market fluctuations because it limits losses to what has already been lost through purchasing power depreciation.
What are covered calls?
A covered call is a risk management tool that dynamically matches the option’s expiration date with the expiration date of an investor’s shares. How covered calls work? When investors go long on stocks, they purchase stock in anticipation of future growth; however, only 50% of portfolio assets can be invested in one security. The other half must lie in cash or short-term investments.
How to use covered calls?
An investor purchases stock and sells a call option on the same number of shares with the same expiration date to create a covered call. This creates a contractual obligation to sell at that price, generating instant income for investors instead of waiting for shares to appreciate. If the stock’s price does not rise high enough by expiration, then the option expires and is worthless and thus has no impact on the long position on the stock.
Put your cursor over ‘Trade’ and select ‘Option’ to place a covered call. From there, indicate who your counter-party will be and what strike price you would like to generate profit from.
Click ‘close’ to exit this position. Your options will automatically be sold, and you’ll receive an immediate debit for them. Never forget that if the stock doesn’t reach your strike price by expiration, your only other possible outcome would be to let it expire.
When using covered calls, you must ensure that you have enough cash in your account to close off any positions that might arise before that time elapses or else leave yourself at risk of defaulting on your trade. This strategy will only work if you are confident prices will stay within a specific range, so always be sure to verify this using your trading platform’s price history graphs.
Benefits of using covered calls?
Covered calls are among the best ways to generate consistent income in the UK when you don’t have time or inclination for more active trade management. Best of all, it requires very little work on your end after entering into a contract with another trader; the only real responsibility possessed by you is ensuring that you do not leave any money in your account that might be at risk if prices suddenly change direction.
Remember, though, that since you’re essentially ‘selling‘ stocks, there is an inherent risk involved that they will fall in value before expiration, which means this strategy may not be suited for everyone. However, if you can overcome these minor difficulties, you’ll find that this is an excellent way to generate income.
The potential benefits of using covered calls are clear, though: You still make a return on your original investment, plus you can use the premium from selling the option as pure profit.
However, there is a reason why it’s only suitable for more experienced traders. If you are not confident enough to buy or sell shares at a predetermined price before expiration, then this covered calls strategy probably isn’t right for you.
But if you have already got some experience and would like to try out a new way of making money through options, we recommend using a reputable online broker from Saxo Bank. Get more information about covered calls on their demo accounts on their website, visit now and start your investment journey today.