Candlestick Trading Blog

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Stock market strategies - education is critical and everyone should learn the terminology of the market. It is difficult to be effective in the market if you don’t understand the difference between long term investing and day trading. Once you understand stock market basics  and stock market terms, you can begin to learn and implement the strategies needed to be successful in the market. Covered calls are an excellent “first strategy” to learn; selling a covered call means that there are investors willing to pay for the right to take a stock if it reaches a much higher price. Selling calls requires that you have at least 100 shares of a stock. It is an excellent strategy to implement while waiting for a stock to reach your identified sell point. This technique can be used over and over, and it can be a great way to create income.

As you analyze trends in the market and identify sell points, you will find times when you are looking to take profits as the market adjusts. Selling covered calls is an excellent way to indulge in a little profit-taking while holding on to the shares for a sell-off at a later date.

An example of covered calls…
We have defined covered calls; by selling calls, you are able to accumulate income passively over time by collecting the premiums on your options. If your option doesn’t reach and maintain the strike price during the time period, the premium and the stock are yours. If the market price of the stock does reach your strike price, you make a nice profit selling the stock and you can purchase more of it in the future if you desire.

Let’s say that you have 300 shares of MEW Industries that you purchased for $15 per share. You are either bearish on the stock market in general or your research indicates that MEW Industries is poised for a bearish move. You want to hold this stock so you are looking to sell covered calls instead. You opt to sell out-of-the-money call options, meaning that your strike price of $20 is above the current market price of $15. The premium on this sale is $0.50 so you immediately pocket $150 or 300 shares multiplied by $0.50. If MEW Industries’ stock prices don’t reach $20 before the expiration date of your covered call option, you retain the stock and the premium is yours. In addition, you can sell more covered calls on these shares if you wish creating more income. If you duplicate this covered call two more times, you have paid for your stocks, ignoring commissions of course!

What happens if the stock does reach the strike price? This is even better; if the stock reaches your strike price of $20, you would have to sell it to fill your covered call. Three hundred shares at $20 is $600 and you get to keep the premium as well, bringing your total to $750.

Selling covered calls not only works well in a bear market but also when a bull market peaks and creates a bearish lull for a particular stock. Selling covered calls is a good technique for long-term investors who want to keep certain stocks but are seeking protection for possible declines. With a few covered calls worked into your stock portfolio, you’ve actually created your own hedge fund without the high fees that normally accompany them.