Covered-call options provide immediate income to your portfolio, a derivative sold against your Exchange-Traded Fund or listed equity position, providing added income, a dividend in a sense, and reducing downside risk in case of a market downturn. This strategy adds the safety of a downside hedge, and it’s free of charge to you as a Caritas client, no transaction costs, no fees, just added income and safety.
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In summary, mechanically, the open long position is slightly “sold short,” synthetically, through the option (a derivative on the underlying security). This conservative and commonly used strategy to provide greater returns works best in slowly rising or sideways markets, as well as in cases of concern over an impending down market (as a safety net, or hedge, in order to mitigate possible losses). In a rapidly rising market, covered-call options do reduce total potential capital returns, but still do provide additional income and safety to the investor.
We at Caritas have a proven, proprietary covered-call options strategy, and it safeguards our clients against market downturns, reduces volatility, provides greater income to the portfolio, and allows our clients to sleep well at night, relatively speaking.
[Direct from Wikipedia, for your information, the history of options and how they have been around and in use for centuries.]
Historical uses of options
Contracts similar to options have been used since ancient times. The first reputed option buyer was the ancient Greek mathematician and philosopher Thales of Miletus. On a certain occasion, it was predicted that the season’s olive harvest would be larger than usual, and during the off-season, he acquired the right to use a number of olive presses the following spring. When spring came and the olive harvest was larger than expected he exercised his options and then rented the presses out at a much higher price than he paid for his ‘option’.
In London, puts and “refusals” (calls) first became well-known trading instruments in the 1690s during the reign of William and Mary. Privileges were options sold over the counter in nineteenth century America, with both puts and calls on shares offered by specialized dealers. Their exercise price was fixed at a rounded-off market price on the day or week that the option was bought, and the expiry date was generally three months after purchase. They were not traded in secondary markets.
In the real estate market, call options have long been used to assemble large parcels of land from separate owners; e.g., a developer pays for the right to buy several adjacent plots, but is not obligated to buy these plots and might not unless he can buy all the plots in the entire parcel. Film or theatrical producers often buy the right — but not the obligation — to dramatize a specific book or script.
Lines of credit give the potential borrower the right — but not the obligation — to borrow within a specified time period.
Many choices, or embedded options, have traditionally been included in bond contracts. For example, many bonds are convertible into common stock at the buyer’s option, or may be called (bought back) at specified prices at the issuer’s option. Mortgage borrowers have long had the option to repay the loan early, which corresponds to a callable bond option.
Modern stock options
Options contracts have been known for decades. The Chicago Board Options Exchange was established in 1973, which set up a regime using standardized forms and terms and trade through a guaranteed clearing house. Trading activity and academic interest has increased since then.
Today, many options are created in a standardized form and traded through clearing houses on regulated options exchanges, while other over-the-counter options are written as bilateral, customized contracts between a single buyer and seller, one or both of which may be a dealer or market-maker. Options are part of a larger class of financial instruments known as derivative products, or simply, derivatives.
[Directly from Investopedia, regarding Covered Calls specifically, for informational purposes and ease of understanding, please read below.]
The Basics of Covered Calls
Widely viewed as a conservative strategy, professional investors write covered calls to increase their investment income. But individual investors can also benefit from this simple, effective option strategy by taking the time to learn it. Let’s take a look at the covered call and examine ways that you can use it in your portfolio.
What is a Covered Call?
As a stock owner, you are entitled to several rights. One of these is the right to sell your stock at any time for the market price. Covered call writing is simply the selling of this right to someone else in exchange for cash paid today. This means that you give the buyer of the option the right to buy your shares before the option expires, at a predetermined price, called the strike price.
A call option is a contract that gives the buyer of the option the legal right (but not the obligation) to buy 100 shares of the underlying stock at the strike price any time before the expiration date. If the seller of the call option owns the underlying shares the option is considered “covered” because of the ability to deliver the shares without purchasing them in the open market at unknown – and possibly higher – future prices.
Profiting from Covered Calls
For the right to buy shares at a predetermined price in the future, the buyer pays the seller of the call option a premium. The premium is a cash fee paid to the seller by the buyer on the day the option is sold. It is the seller’s money to keep, regardless of whether the option is exercised.
When to Sell a Covered Call
If you sell a covered call, you get money today in exchange for some of your stock’s future upside.
For example, let’s assume you pay $50 per share for your stock and think that it will rise to $60 within one year. Also, you’d be willing to sell at $55 within six months, knowing you were giving up further upside, but making a nice short-term profit. In this scenario, selling a covered call on your stock position might be an attractive option for you.
After looking at the stock’s option chain, you find a $55, six-month call option selling for $4 per share. You could sell the $55 call option against your shares, which you purchased at $50 and hoped to sell at $60 within a year. If you did this, you would obligate yourself to sell the shares at $55 within the next six months if the price rose to this amount. You would still get to keep your $4 in premiums plus the $55 from the sale of your shares, for the grand total of $59 (an 18% return) over six months.
On the other hand, if the stock falls to $40, for instance, you’ll have a $10 loss on your original position. However, because you get to keep the $4 option premium from the sale of the call option, the total loss is $6 per share and not $10.