A covered call is a type of option that helps an investor earn income on the stocks in his possession. Typically, these are the stocks in the portfolio that the investor wants to sell. The investor sells a covered call option to an interested buyer, which gives the buyer the right to purchase the underlying stocks at a specified price in a given time period, usually one month. The investor can control the amount the buyer pays for the covered call with a limit order. The limit order ensures that the buyer pays at least the stated amount or more per share in the call order.
1. Set a strike price for the covered call. This is the price at which you are willing to sell each stock underlying the covered call. Your strike price will affect the amount you receive for the covered call option. According to Fidelity, the premium is less valuable if your strike price is higher than the current price of the stock.
2. Watch how covered calls are trading in real time. You may do so via investment trading portals online. The authors of “New Insights on Covered Call Writing” recommend taking note of the bid and ask prices.
3. Set your limit order halfway between the bid and ask prices for the covered call options on the market. For example, you may set your limit order at $3.00 if the common bid price is $2.80 and the common ask price is $3.20. According to the authors of “New Insights on Covered Call Writing,” options trade in increments of 5 cents if the price is set under $3.00 and in increments of 10 cents if it is set above $3.00.
4. Set an expiration date. Covered call options expire on the third Saturday of the chosen month, but trading ends on the Friday before the date of expiration.
5. Place your trade. You may enter the details of your trade online through your brokerage firm’s website or you may contact your broker by phone. Provide the name of the shares, the expiration date, the strike price and the limit order for the broker to process the trade.
6. Monitor your trade through the day or wait for notification of a buyer from your broker.
7. Monitor the price of the stock while the covered call is valid. The buyer may call the stock away from you, at the strike price, if the price increases, or let it expire if it does not. In either case, the premium the buyer has paid is your income.
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