Covered Calls - Trading Options To Lower Your Risk

By: Robert Hauver Click author's name for more of his/her articles

"Are you, nuts?! You want me to risk part of my savings trading options? This whole covered calls idea sounds like just another one of those crazy options strategies that sound great, but don't deliver in the end."

My pal was a normally a mild-mannered sort - very contemplative, always weighing the consequences rationally before acting. In short, a logical thinker.

Imagine my dismay when that one phrase, "trading options", triggered this unprecedented tirade. You'd think that I'd insulted his family or maybe something worse.

After a few moments had passed, I realized the reason for my friend's outburst. He, like so many other investors, had only lost money trading options.

Why? Because he'd never discovered the number one option trading secret: 3 out of 4 options expire worthless. You read that correctly, when you trade options as a buyer, you have a 25% chance of making money, and a 75% chance of losing money.

This is why professional traders and investors favor the option strategy of selling options, rather than buying them, in hopes that the trade will go their way.

"Wait a minute. How can all of those options just expire worthless? I've seen ads for 100's of option strategies and trading systems on the internet. They can't all be losing money."

I had to smirk. Now I really had him thinking. He knew that I hadn't yet told him the big "secret behind the secret", but he couldn't quite put his finger on it.

"I have one word for you, my doubting friend", I said,..."Time". "When you become an option seller, you have time working FOR you, instead of against you. The reason is simple - as puts and calls get closer to their expiration date, they keep losing their time value, due to "time decay", or theta, the Greek letter that option traders use to denote the % of change in time value of an option."

This is true of any option, no matter if you're buying or selling call options or put options, or using a covered call strategy. It's one of the big secrets of options investing that doesn't get written about too often.

Because of the power of time decay, you can actually guess wrong about the direction of the market, or a stock, and you'll still make money selling a call option or put option, as opposed to the buyers on the other side of the trade, who not only have to guess the stock's future price movement correctly, but must do it BEFORE the option expiration date.

This helps to explain why even conservative investors use the covered call strategy, which is widely considered one of the most conservative option trading strategies around.

To sell covered calls, you must own at least 100 shares of the underlying equity, since each call contract corresponds to 100 shares of the underlying stock.

This is a tool you can use to hedge your portfolio, and lower your risk, by receiving "call premium" money, which lowers your break-even cost basis.

Selling covered calls is a short-to-mid-term option strategy you can use to double and triple your yields on new stock purchases, and/or to earn more income from your existing portfolio.

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About The Author: Want to make money selling Covered Calls? Visit this blog: hubpages.com/hub/CoveredCall to see an option table explained, to learn all the option terms you need to know, and to see a step-by-step actual trade example of how to sell covered calls. Author: Bob Hauver, MBA