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Writing covered calls is one of the easiest and least risky option trading strategies used by investors today. The term “covered” refers to the notion that you own the stock in which you are selling the call contract against – thus being able to cover the shares. In the event that the buyer “calls” the contract, you will be forced to sell he/she the stock at the strike price. If you didn’t previously own shares of the stock and the buyer called the contract – you would be forced to purchase the stock at it’s current market value in order to sell it to the buyer for the strike price. This is known as a “naked call”. The risk of selling a naked call is that no matter what price the stock is at, you are required to go out and purchase the shares and deliver them to the buyer of the option contract.

There are several different reasons why you may want to sell or “write” covered calls. It could be that you are looking to generate some cash flow against your stock portfolio. You could also purchase 100 shares of a stock and immediately sell 1 call contract with a strike price just above the amount you paid for the stock. This strategy ensures that you will immediately reduce the average share price you paid for the stock. If the stock price rises and you lose the stock, then you still come away with a gain. If the stock remains steady or decreases, then you have bought into the stock at a lower rate. There are also many other advanced strategies that can combine writing covered calls with other types of options.

Here are the high level steps involved in writing a covered call option. Before we begin, remember an option contract (puts and calls) represents 100 shares of the underlying stock. So in order to sell 5 covered call contracts, you would need to own 500 shares of the stock.

1. Stock Screen – The first step is to use a free online stock screening tool to select the stocks you would like begin writing covered calls against. Search for high quality companies that have strong balance sheets and are stocks that you would want to own in your portfolio. You may also want to consider screening for dividend producing stocks to bring in some extra income overtime.
2. Purchase Stock – The next step in writing covered call options is to buy stocks online if you don’t already own at least 100 shares of a security. Decide how many contracts you want to sell to determine the number of shares you need to own in your portfolio.
3. Identify Call Contracts – Once you own the stocks, it is time to identify the call options you would like to sell. Option contracts vary depending on strike price and expiration date. If you are interested in keeping the stocks long term, you should consider selling the calls out of the money. Out of the money calls represent a strike price that is higher than the current price.
4. Sell Covered Call(s) – The final step in writing covered calls is to sell the identified contracts against the stocks you own. Consider using a discount online stock broker to lower your commission costs, which will make the transactions more lucrative.

Are you ready to start implementing your option trading strategy?

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