The covered call options strategy can give a significant boost to the income generated in your brokerage account, but, like all investing strategies, it carries it share of risk. The strategy involves buying shares of stock and at the same time selling call options that are backed by those shares. Since a covered call has two parts, closing the position may entail one or both parts, depending on the outcome you want.
Sold Call Options
When you sell call options as part of a covered call trade you receive money called a premium in exchange for an obligation. If the buyer of the option chooses to exercise the call, you must deliver the shares of the specific stock and accept the price -- called the strike price -- listed on the call. One call option covers 100 shares of stock, so you can sell one contract for each 100 shares you own. A covered call trade can be established by selling calls against shares you already own, or entering a trade to buy the shares and sell the calls at the same time.
Keeping Your Stock
If you have a covered call position and you want to uncover but hang on to your stock, you need to buy back the call options you sold. If you enter a buy order for the same options you sold to establish the covered call, the trade will offset the sold calls and get you out of the covered call. The price you pay for the call options may be higher or lower than what you received when you sold the contracts. In this scenario, you are buying the options to get out of your covered call.
Closing The Entire Trade
If you want to be completely out of a covered call position, you will need to sell the stock as well as buy back the sold call options. The order of the trades is important to accomplish this goal. You must first buy back the options, and then you can sell the stock shares. You can place the trades one after the other, but make sure the calls trade has completed before selling the stock. You sell the calls first to avoid being uncovered for sold calls in your account.
Reasons to Close Covered Call
You may want to close all or part of your covered call position if the stock price either climbs too high or drops significantly in value. If the stock price goes up, the buyer of the call can exercise the call option and take your shares at the option strike price. If you really want to keep the shares, buying back the options eliminates the potential of the stock being called away. If the stock goes down, the whole strategy of trading covered calls for income stops working. In this case you want to minimize your losses by both buying back the call and selling the stock.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.