LEAPS Covered Calls

LEAPS covered calls are much like other stock covered call options that investors can use to generate cash income in their stock brokerage accounts, but with one important difference.  The difference is that LEAPS, or Long Term Equity AnticiPation Securities, have expiration dates longer than one year.  An example might help to explain how to use LEAPS covered calls to your advantage.

First, if you are not familiar with options trading, a call option gives the buyer the right, but not the obligation, to buy a pre-determined quantity of an asset, usually a stock or commodity, at the specified price (strike price), on or before the expiration date of the option contract.  A covered call  option is just a standard call option where the seller is covering the contract with securities that are already owned in their brokerage account.  LEAPS covered calls are standardized call option contracts with expiration dates over one year away, that are secured by the shares of stock that are already owned in the sellers trading account.  Since each LEAP option contract represents 100 shares of stock, these covered options 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 200 shares of General Electric (GE) in their brokerage account, they would be able to write (or sell) 2 LEAPS covered calls.

The longer expiration dates that LEAPs possess give long term investors the ability to get exposure to long term price changes, with no need for a combination of shorter-term option contracts. Also, the premiums (price) for LEAPs are higher than for standard options in the same stock because the increased expiration date gives the underlying stock more time to make a large price move and for the investors to make a good profits.  Conversely, for the investor writing LEAPS covered calls, they get a higher cash payment up front for taking on the risk that they may be called out of their stock over the longer time frame contained in the covered LEAP contract.

One other characteristic that an investor considering writing LEAPS covered calls should consider is that the price decay of a LEAP call option is much slower than an option with a much nearer term expiration date.  For instance, if a call option with a strike price  equal to the underlying stocks current price only has a month to expiration, and the underlying stock price stays flat, the price of the call option will decline to nothing over the final month of the contract.  However, a leap contract will register a very minimal reduction in price over the same month, due to it’s longer time to expiration.

Technorati Tags: Anticipation, Brokerage Account, Call Option, Call Options, Covered Calls, Covered Option, Covered Options, Diversification, Exercise Price, Expiration Date, Expiration Dates, General Electric, Increments, Investor, Leaps, Long Term Equity Anticipation Securities, Option Contract, Option Contracts, Options Contracts, Premiums, Price Changes, Price Move, Purchase Shares, Stock, Stock Brokerage Accounts, Stock Market, Stock Ownership, Stock Price, Substantial Move, Term Equity, Term Investors, Term Option, Term Options, Traded Options

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.

Technorati Tags: Additional Income, Call Option, Call Options, Cisco, Cisco Systems, Commodity, Covered Call, Covered Option, Csco, Dividend, Expiration Date, Increments, Individual Retirement Account, Investment Portfolios, Ira, Option Contract, Options Trading, Stock Investing, Stock Market Investors, Stock Price

A call option is a useful tool for stock market investors to master.  First I will go over what a call option is, then descrcibe why it is a valuable tool for stock investors.  Just a note – I am going to describe standard options contracts that are traded in the United States.

Call option definition – an option contract that gives the current holder the right, but not the obligation, to buy 100 shares of stock in a specific company, at certain price (the options strike price), by a specific date (the expiration date).  Conversely, the seller of the option contract is obligated to sell 100 shares of the specified company to the holder of the contract, for the strike price of the contract, if the contract holder exercises his right to buy the stock on or before the expiration date.  This explanation probably needs an explanation to make the principal clear.

Lets say an investor holds 100 shares of General Electric (GE) in his trading account.  The dividend was cut, so the investor decides to sell a covered call option to generate some income, using his 100 shares of GE as collateral to “cover” the transaction.  The investor notes that the price of GE is currently $15, and the investor thinks it will probably stay under $20 over the next two months, so he sells a $20 call option, with an expiration date that is two months out, and he receives $1 per share ($100 total) in cash for the option contract.  At this point, the investor with the GE shares in his account is obligated to sell whoever is holding the call contract his 100 shares of GE stock for a price of $20 per share, until the contract expires.

So we’ve looked at why someone would sell covered option calls contracts – because they want the income, and do not believe the stock price will go above the strike price of the contract, but why would someone buy the GE call option contract?  Because they believe the stock may experience an upward move in price, and by utilizing only $1oo, they actually control 100 shares of GE stock, and can profit on any move over the strike price.  For instance, if GE went up to $25, the contract holder could call away the stock from the contract seller for $20 per share, and immediately turn around and sell the stock for $25, locking in a nice 400% profit in a period of two months.

As you can see, a call option can generate income for the person who sells the contract, as well as occasionally being a lucrative investment for the person who buys the contract.

Technorati Tags: Call Option, Collateral, Contract Holder, Covered Calls, Dividend, Expiration Date, Ge Stock, General Electric, Investor, Obligation, Option Contract, Options Contracts, Specific Company, Stock Investors, Stock Market Investors, Stock Price, United States, Upward Move, Valuable Tool

Stock Market Breadth

The definition of stock market breadth is the number of stocks participating in an overall stock market index price move, whether the stock price is moving up or down.  Market breadth is useful in determining the strength of a stock market trend.  The theory is that the more stocks participating in stock market trends, the stronger the price trend.  Many analysts have noted that a divergence between the price of stock market indices like the S&P 500, and the breadth of stocks participating in the trend can lead to a price trend reversal.  Using market breadth indicators may give you an edge in stock market timing, giving you an advanced view of when to tighten your trailing stop loss orders.

Market Breadth Indicators

Market breadth indicators come in a variety of forms, and they all have the intent of measuring the underlying stock participation in a rally or sell-off.  Most popular breadth indicators can be roughly divided into three categories:

1) Indicators based on stocks making new highs or new lows

2) Indicators based on stocks above or below a moving average

3) Indicators based on stocks that are advancing or declining in price

There are other market breadth stock market indicators, some, like the McClellan Oscillator, are a combination of those just mentioned, while others are based on an aggregate view of stocks exhibiting a particular technical indicator trait (for example the number of stocks in an index with an RSI value >= 90).

Stock market breadth indicators have been classified as technical analysis of stock market trends, as they do rely on the price action of individual stocks.  They are also sometimes referred to as stock market internal indicators.

Understanding the stock market is all about knowing which side of the trade you should be on (long or short), and this easier when you start with a top down analysis, which should include a study, and ongoing review, of stock market trends and their underlying strength using market breadth as a guide.

Technorati Tags: Divergence, Index Price, Lows, Market Breadth Indicators, Market Stock, Market Trend, Mcclellan Oscillator, Moving Average, New Highs, Price Move, Price Trend, Rally, Stock Analysis, Stock Index, Stock Indices, Stock Market Index, Stock Market Indicators, Stock Market Indices, Stock Market Timing, Stock Market Trends, Stock Price, Stock Trend, Stock Trends, Stocks, Technical Analysis Stock, Technical Indicator, Timing Stock, Trailing Stop Loss, Trend Analysis, Trend Reversal, Trend Stock, Understanding The Stock Market

Highest Dividend Stocks

Income investors looking for a good return on their investment often look for the highest dividend stocks, or more precisely, the highest yielding dividend stocks.  This can also be a good place for value investors to look for potential buy candidates because high dividend yields can be caused by a stock price being temporarily low (i.e. undervalued stocks), which simultaneously raises the yield.  However, the highest dividend stocks can also be a dangerous place to find buy candidates.

Normally when income investors are looking for dividends stocks, they are looking at monthly dividend stocks or stocks that pay dividends quarterly with the highest yield (adjusted for risk).  The issue with the highest dividend stocks on the top dividend stock list is that they are usually amongst the most risky stocks a conservative income investor will look at.  Many of these stocks have high dividend yields because the underlying stock price has fallen, while the dividend payment is presumably staying the same, giving the appearance of a high yield.  Stocks with high dividends should raise a flag with any income investor to be extra diligent doing their homework.  The biggest question you’ll need to ask yourself is whether or not the dividend is safe?

The first thing an income investor should screen for in stocks paying dividends is whether or not the stock is consistently profitable.  As they say on Wall Street, profits drive dividends, and many times, stocks with high dividends are also losing money – their dividends place them on the highest dividend stocks list because of the additional risk.

Another attribute that you should look for in profitable top dividend stocks is how well their earnings cover their dividends – also known as the dividend payout ratio.  Ideally, you want to see a stock paying out less than 50% of it’s earnings as dividends.  If the high dividend stocks you are looking at have a dividend payout ratio of 50% or less, the dividend has a higher probability of being safe – in other words it is less likely to be reduced or cancelled.

Technorati Tags: Array, Attribute, Dangerous Place, Dividend Payment, Dividend Payout Ratio, Dividend Stock, High Dividend Stocks, High Dividend Yields, High Yield Stocks, Highest Dividend Stocks, Highest Yielding Dividend, Highest Yielding Dividend Stocks, Investor, Monthly Dividend Stocks, Profitable Stocks, Risk, Risky Stocks, Stock List, Stock Price, Stocks That Pay Dividends, Stocks With High Dividends, Top Dividend Stocks, Top Stocks, Undervalued Stocks, Value Investors, Wall Street