Covered Leaps

Selling covered LEAPS (Long Term Equity Anticipation Securities) is a popular way for stock market investors to generate income with their stock portfolios, without necessarily having to sell their stock.

Covered Leaps are very similar to covered calls.  What sets leaps apart from regular options is primarily the length of time until they expire – a leap has a much longer time before it expires, vs. standard options you may already be trading.  This gives the option seller the advantage of receiving more premium money up front when the option is sold, due to the relatively long time to expiration.

The way investors use covered LEAPS  to make money is by selling a leap option contract, using stock already held in their trading account as collateral.  If this sounds familiar, it is just like writing a covered call.  Thats right, LEAPS represent 100 shares of stock, just like a regular call or put option.  The main difference between a regular options contract and a LEAPS contract is the length of time to expiration. 

There are several advantages that covered leaps have over normal stock covered calls.  First, you receive a larger premium up front.  This is due to the longer time to the option expiration date.  Next, if you are executing a covered call strategy where you sell a new call contract against your stock when the old one expires, you will have lower trading commissions with LEAPS.  Finally, with the longer time horizon associated with LEAPs, an individual investor has a longer time period to plan out with a known risk/reward factor.

As you can see, covered LEAPS are as easy to use as regular options, and can provide you with several advantages when using them in a covered call strategy.  You should consider using them in your covered call writing strategy.

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Stock covered calls are a technique use by stock market investors to generate additional income from stocks that they already own in their investment portfolios.  While options trading may sound scary, this technique for generating income is actually so conservative that most brokers will even let you utilize this technique in your online Individual Retirement Account (IRA).

A call option gives the buyer the right to buy a pre-determined quantity of an asset, usually a stock or commodity, at a specified price (strike price), on or before the expiration date of the option contract.  A covered call option is a standard call option that the seller is covering with securities that are already owned in his trading account.  Stock covered calls are merely standardized call options that are secured by the shares of stock that are already owned in the sellers trading account.  Since each option contract represents 100 shares of stock, these covered option calls can only be sold (also known as writing a call option) based on full 100 share increments of the underlying stock that the option is being written against.  For example, if an investor holds 670 shares of Cisco Systems (CSCO) in their account, they would be able to write (or sell) 6 stock covered calls.

Now that we’ve gone over what stock covered calls are, lets look at how to use them.  Lets continue with the example of the investor with 670 shares of CSCO in their stock market investing account.  Since CSCO does not pay a dividend, and the investor wants income without having to sell his stock, he decides to sell call options that will expire in two months, for a price that is above todays stock price for CSCO.  In return for this option, the investor gets $1 per share, or $100 per covered option calls contract, times 6 contracts equals $600.  This cash is deposited directly into the investors trading account, and can be used for whatever purpose the investor chooses.  The investor is now obligated to sell the contract holder 600 shares of stock at the price specified in the contract, on or before the expiration date of the contract. 

Now if the stock price does not go above the contract strike price, the investor who sold the option contracts keeps his stock, and the cash he got from selling the stock covered calls, and can do it all over again on the trading day after the contract expires.  This is a very powerful concept, since it means that the investor can generate income multiple times per year by selling these call options. 

If the stock closes above the price specified in the contract, usually around the date the contract expires, the contract will be exercised by the option holder, and the investor will have to sell him the 600 shares of CSCO at the price specified in the option contract.  Since the contract price is above the price that the stock was trading at when the options were sold, the investor gets that capital gain profit, plus the cash that he was paid for selling the options.

While stock covered calls may seem a little complicated at first, in the end they provide you with a relatively easy way to generate cash flow on stocks that would otherwise just be sitting in your investment account.

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Covered Call

A popular strategy amongst investors looking to generate extra income from their portfolios is to sell a covered call option on stock that they already own in their investment portfolio.  Selling covered calls can be a good way to generate regular income on stocks that do not even pay dividends (but you can use this income producing strategy on dividend stocks too).

First, lets look at how this strategy works.  In this example, you own 100 shares of XYZ company in your investment account, it pays no dividend, and while you expect it to increase in price over time, it isn’t gaining in price very quickly, so you’d like to generate income with the stock until it hits your target sell price.  To do this, you sell a covered call option contract against your 100 XYZ shares (your 100 shares “cover” the contract as collateral).  In this scenario, somebody pays you cash that goes into your investment account, and no matter what happens next, the cash is yours to keep.  The terms of the contract are very simple – you promise to sell your 100 shares of XYZ to the person who holds the contract at the price specified in the contract, by the date the contract expires – this last term is very important. 

To continue our example, lets say XYZ company is currently selling for $20 per share, and you sell a call option using your 100 shares of XYZ stock as collateral with a strike price of $25, and a contract expiration date two months from now.  You receive $1 per share for your covered call contract, or $100 total, which is deposited into your investment account.  As long as the stock is less than $25 over the next two months, you will keep your stock, and the $100 you got for selling the contract.  In this case, you will be able to to do the same thing again after two months, up to six times per year.  In this example, you would be able to generate up to $600 in option income over the course of a year, from a stock that was just sitting in your online trading account.

What if the stock had risen above $25?  In this case, you would most likely have to sell your stock to the covered option calls contract holder (this is done automatically by your online broker), for $25.  So in this case, you would get the $25 per share for your stock, plus the original $1 per share that you kept from the sale of your option contract, for a total of $26 per share (or $6 per share gain from your $20 starting price) – not a bad profit for two months of risk in the stock market.

In order to execute this strategy, you will need to sign up with your stock broker to trade options in your account.  This strategy is so so conservative, that many brokers actually allow you to sell covered call contracts in your retirement IRA account.

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