Writing Options and Writing Covered Calls

Writing Options
Investors can also write or sell options which provide them with additional incomes with received Premiums from buyers of the option contracts.

The positive potential of this strategy for the option writers however, is limited due to the most money that they can get is the amount of the option Premium.

There are two ways to write options. The conservative method is to write covered options.

A covered option is an option that is written against an underlying stock that is of possession or sold short by the writer. The writer of the option is the owner of the stock against whom the options are written.

The second method is the writing of a naked option which is an option written on an underlying stock that is not owned or sold short by the writer.

Writing covered calls
Investors that look for the ways to increase their incomes in stocks that they already own can write covered calls. This strategy works as a call, with the exception that the writer in this case is the owner of the stock.

The following example will illustrate how writing covered calls work. Let?s pretend that an investor is owner of 1000 shares of Citigroup stock that were bought sometime ago at $25 per share. Citigroup is selling at around $48 each share. Instead of selling the stock immediately, the investor can write call options over Citigroup. If the investor writes 10 call contracts of 100 shares each with a $50 strike price at a $2 Premium per share ($2000 for 10 contracts) expiring in September, he will get the amount of $2000 minus commissions. If the Citigroup stock never raises above $50 per share before expiration date, the buyer will not carry out the call and the writer will end up with an additional $2000 (minus commissions on the options contracts).

If the price of the stock raises above $50 per share, the buyer exercises the call and buys the stock at $50 per share. The writer gets a benefit of $27 per share ($50 minus the $25 cost of the shares plus the $2 per share premium). This is the maximum benefit that a writer can get from the covered call option, even if Citigroup raises shares at $100 each. This additional appreciation will be lost because the writer must render stock at $50 strike price.

To sum up a covered call limits the appreciation that the writer can achieve for which it is a good idea to write covered calls in the stocks that you think could not go up or fall too much in price.

On the other hand, if the stock fall significantly in its price during the period of the option the writer will lose money if eventually sells the stock at a low price. The call buyer will not exercise the call  because the market price of stocks will be cheaper than strike price.