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Author: IsaacHarrison70 Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 221  
Subject: Re: Covered Calls Date: 2/25/2002 11:01 AM
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Andersol,

in addition to the links offered up, I will give you a couple of guidelines on writing covered calls.

It is really only profitable to write a covered call (also called "selling a covered call") if you have the following scenario:

1. You purchased a stock over a year ago and it has grown in value. Let's say you bought Canadian National Railway at $34 a year ago and it is now selling near $48.
2. The stock pays a healthy dividend, which means you get some income from it. Let's say in this case it is a 2% yield.
3. You believe the stock is at or near its peak in terms of value. In other words, you think it might go up to around $50 or so, but not beyond that.

You can now write an options contract, and this is done through a broker -full service or discount. Let's say it is March and you write a July 50 CNI call option. Someone will purchase this contract from you at a premium (which varies widely). Let's say the premium is $2.50 per contract, each contract good for 100 shares.

you receive $250 and keep this regardless of what happens.

The person who buys the contract from you has the RIGHT, but not the OBLIGATION to exercise the option and purchase 100 shares of CNI from you at $50 at or before July. So what happens?

Let's say the stock goes up to $52 and the option is exercised. You have done the following:

Earned $16 per share in stock appreciation (because you bought it at $34)
Received a $250 premium for selling the option
Earned 5 quarters of dividends (or more)

The worst that can happen here, is that you miss out on some opportunity if the stock shoots up to $60 and you are exercised. If the option is not exercised, you simply pocket the $250 minus fees (around $30 or so for writing the contract). You can also purchase your contract back if you don't want it exercised -sometimes at a profit.

Options are important for anyone who is interested in advanced investing. Covered Calls are a way to increase profit and income from securities. It should be mentioned, however, that they are not a protective measure. To do that, you would purchase a protective put

-but that is a whole different discussion.

V
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