Sunday, March 12, 2006

Selling covered calls

Selling covered calls is one (conservative) way to make money off a stock stuck in a trading range. The idea is to sell a call on a stock that you already own. If the stock shoots up, your stock will be called away (sold) and you'll get for your stock the strike price plus the premium you collected when you sold the call. For example, Microsoft closed Friday at $27.17. The July 2006 27.50 call closed at $1. If you sold one and the stock went up you'd get $27.50 + $1 = $28.50 for your stock. If it closes below $27.50 in July, you can just pocket the $1 premium and keep your stock. If it drops, hey bad news, but at least you have $1 per share to cushion the loss somewhat.

What I do is determine a trading range. MSFT in the last year has traded in the $24 to $28 range. When it gets near the top of its range, sell covered calls at a strike price as near as possible to the current price. If the stock drops down to the lower part of the range, buy your call back to take your profit and close the transaction. You can do this over and over if you are lucky.