Covered Options Trading

Covered options trading means trading options on stock that you already own. Covered options trading does not provide the leverage that uncovered options trading does but it is typically safer. Investors usually sell options on stock that they already own to increase their profits. Investors buy put on stock that they already own in order hedge risk. They buy call options to lock in opportunity without a large cash outlay.

Of the various kinds of options trading covered options trading is the most conservative. We will look at buying and selling the covered call option and the covered put option. The covered call option is a long options strategy. Although the investor already owns the stock he or she would be very pleased to buy more but only if the stock is going to go up or continue to go up in price. By purchasing a call option on the stock the investor locks in the opportunity to buy, at the strike price, when the stock’s spot price rises. An investor will typically sell a call option on stock he or she owns if the stock is not likely to go up in price. In this case the investor usually has a cyclical stock that is near its traditional high. By selling a call option on the stock the investor gains the premium paid for the option. The premium helps offset the portfolio loss as the stock cycles back down to its lower range. Because the buyer does not execute the options contract the investor keeps a good stock.

When is trading put options a good option? When you own a stock that has just had a big run up in price and you want to lock in your gains in a volatile market. In this case the investor buys a put on the stock that he or she owns. The put gives the investor the right to sell the stock on or before the contract expiration date at the agreed upon contract price. This price, the strike price, is the current price of the stock after a substantial run up. If the stock correctly heavily the investor will exercise the put option and sell the stock at the contract, strike, price, and buy again at the lower market or spot price. An investor may also sell a put option on a stock that he or she owns.

Whereas buying a put option on a stock you own is a type risk management in options trading selling a put on your stock is just for profit on the premium. This case is similar to selling covered call options. The investor does not expect the stock to fall in value even through the buyer of the put does. The investor expects to gain the premium and to keep a promising stock. If the stock does drop substantially in price the investor will have to buy at the strike price but can use the stock he or she has to help with the cost. If the stock drops very badly then the investor will wish that he or she had been more careful writing puts in options trading. Over the long term writing puts is statistically more profitable than buying them. The problem is having the collateral to cover an occasional bad trade. Owning the stock already provides collateral for the occasional loss in this type of covered options trading.

Related Articles

• 5 Careful Ways to Win with Options (benzinga.com)
• Sprint Nextel Options Actively Traded Suggest a Decrease In Price Movement (S) (benzinga.com)

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