Investment Basics

When you first begin learning about covered calls, it is easy to become a bit overwhelmed by the language and information. But covered calls are not much different than other investment strategies. The key is to align yourself with trusted sources of information and to learn as much as you can before diving in. A good CC strategy can lead you to a sound money making source for many needs, but it is not a "get rich quick" scheme. If you are looking to become rich overnight, then you should look elsewhere. If instead you are interested in a steady, dependable way to earn some money, then CCs might be what you are looking for.

Here are some commonly asked questions among beginners:

What are covered calls?

A covered call is a two-part trade. The first part is buying 100 or more shares of stock. The second part is selling a call option against that stock. Because options control 100 shares, you sell 1 call option for every 100 shares of stock you bought. The combination of being long the stock and short a call option is known as a "covered call". It is also called a "buy-write" trade (because you buy the stock and the write (or sell) the option).

What is does "long" and "short" mean where stocks are concerned?

Being "long" a security (stock) means that you own it. This is the normal case. You bought it and if it goes up in value you will make money. Being "short" means that you have sold a security (stock) that you do not own. At some point in the future you will have to buy it back to "cover" your short position.

OK. But how do I make money?

You sell call options to buyers that allow them to purchase at a predetermined price, and they pay you a "premium" that is legitimate whether the option is exercised or not. This guarantees you premiums regardless of the outcome, and creates income that you can count on.

How do I know when to sell these?

You can sell call options against your stock at any time. In fact, you could do it every month if you want to (and generate recurring monthly income). You would not want to do it if you expect the stock to shoot up in value in the very near term. By selling the option you are putting a cap on your upside for the stock (in exchange for the option premium you receive). The best case, for you the option seller, is to have your stock stay the same between the time you sell it and its expiration. That way you collect the option premium, break even on the stock, and can do it again the following month.

Covered calls are not that complicated if you have a good source of trusted information to lead the way. The key is to know which stocks fit the profile, and which stocks do not. Always do your research, check with your trusted source of information and make informed decisions. If you do this, then CCs can make a wonderful source of income for you in the years to come.

Mike Scanlin is the CEO of Born To Sell, a web site for covered call investors that offers an easy to use covered call screening tool, covered call portfolio management, and a covered call tutorial. Armed with the right tools, covered calls are a simple and effective way to generate recurring monthly income.