Jim Woods

Writing Options: Put and Call Writing Explained

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Suppose you're sitting on 1,000 shares of the hypothetical XYZ Corp. with the stock currently trading at $34. Suppose the shares are trading pretty steadily and haven't made a significant jump in a while.

Instead of waiting around and hoping for the stock to receive its own version of a stimulus package, you can take the opportunity to sell calls at the $35 strike against your position.

Let's say the XYZ Oct 35 Calls trade at $1.95 per share. That's $195 per contract, and as one contract covers 100 shares, you can sell a 10-lot, or 10 contracts, for $1,950, so that's the amount of money that you would take in by selling your calls.

Why the XYZ Oct 35 Calls? Well, for two reasons.

One, the strike price is higher than the current market value, which means that you are agreeing to sell your shares for $35 each should the buyer wish to exercise his or her right to buy the stock (i.e., call it away from you). This means that in addition to the $1,950 that you took in, you'd be selling the shares for $1 more than the level where they're currently trading.

Two, insofar as choosing the October calls, their expiration date is far enough away that if you are expecting the stock to move up (so that the options become more valuable), you're giving yourself enough time to be right.

But what if the stock doesn't go up to, or through, that $35 strike by that third Friday in October?

Well, then you'd keep your premium money -- as well as your stock -- because the option buyer wouldn't want to call the shares away from you at a cost that's above the market price. His or her option would likely expire worthless.

Owning stock and selling covered calls against it is like having an apartment building and collecting rent on the available units. If you can't find tenants or just haven't gotten around to renovating a perfectly usable space, then you're not making any money. And in neutral markets, not collecting "rent" with options trading means you could be passing up a lot of gains that you might never see by just holding on to the stock and playing the waiting game.

Related Articles:

• 7 Tips for Writing Covered Calls
• Writing Covered Calls: The Only Certain Way to Generate Income

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