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Profit from Selling Calls
You have invested in Xyz Corporation and the stock has risen nicely. However, your own fundamental and technical analysis tells you that the stock is likely to level off or even experience a correction before continuing upward. You do not want to sell the stock as you firmly believe that it is an excellent medium and long term investment.
However, you would like to benefit from some of the current hype about the stock. Here is a situation where you might want to profit from selling calls on Xyz Corporation. Think of selling calls as an extra dividend. If done right this one of the good times for trading options. But, be aware that if you want to profit from selling calls you also run the risk of missing out on a rise in the stock price.
A call is an options contract. The seller gains a payment for giving the buyer the right to purchase the stock at a fixed price, the strike price, up until the expiration of the contract. If the stock does not rise in price the seller gains the price of the options contract. If the stock rises in price the buyer can exercise the option, purchase at the strike price, and own the stock for less than new market price. The seller, in this case, is paid for the stock and pockets the price of the option. He or she needs to purchase the stock again if he or she believes it is a good investment. This can be a profitable long options strategy.
When Selling Calls is Profitable
The owner of a stock will always profit from selling calls on the stock. He or she will gain the contract price. However, if the owner of the stock really does not want to give up a stock that promises to rise in price he or she must be careful to only sell calls on the stock when the stock price is flat or likely to fall a little during the term of the options contract. In a cyclical stock market it is a common practice for smart investors to profit from selling calls when they believe that the stock has come to its peak.
A person who has owned a stock for a long time and is thoroughly versed in the fundamentals and technical factors that drive its price can often profit from selling calls because of the accuracy of his judgment regarding the stock.
When Selling Calls Can Be Tricky
In general we are talking about covered calls in this article. However, uncovered calls are a different matter. A trader may wish to take advantage of options trading leverage to gain profits in the market. He does not own the stock.
Rather he has a margin account with a stock broker. If his judgment is correct the stock will not rise in price and he will pocket his profits without ever having to invest in Xyz Corporation. However, if the company becomes the target of a takeover bid the stock price may rise significantly. His losses may be significant. In fact, he may be subject to a margin call on his account if losses are bad enough.