Method #2 – Writing Covered Call Options for Income

Covered calls are conservative in one aspect—the cost basis of your long stock is always reduced by the amount of the time premium you sell. That means if you write at the money or in the money calls, the stock can actually stay flat or go down and you still make your maximum profit.

And it also means that even if the trade does goes against you, you still have a certain level of downside protection not available to the simple buy and hold investor.

Writing covered call options for income is not about long term investing — it’s about earning great short term income returns with manageable risk. If you can average 3% returns every month, that equates to 36% a year (actually it’s more when you factor in compounding effects).

[note: the key is average returns, not consistently identical returns every single month – for more perspective on this, please see my related article, “The Myth of Monthly Cash Flow.”]

And 3% (on average, and sometimes more) is attainable if you’re able to navigate some very real pitfalls associated with covered calls:

• Big moves down in the share price will blow through the trade’s inherent limited downside protection and can quickly snowball into a substantial loss.
• Since the emphasis is on short term income rather than long term gains, some basic skills or tools involving technical analysis are essential.
• Identifying the best potential covered call trades can be difficult, if not impossible, on your own and in real time.

These are legitimate risks and concerns, but the good news is that they can be addressed and minimized, making this a viable income strategy.

Covered call options for income can be an effective strategy in a variety of markets — bull, bear, or trending. A mild bull market is obviously the easiest environment for covered call writing, but even bear markets can still be profitable if you make some necessary adjustments (providing the market doesn’t suffer a complete meltdown as it recently did in October 2008).

If you’re new to covered calls and you’re considering writing some covered call options for income yourself, or if you already do write covered calls and you’d like additional information on available resources to help you improve your performance, be sure to check out this indepth discussion and recommendation.