Covered Calls

WHAT IS A COVERED CALL

Traditionally investors seeking to generate income from their share portfolio have relied upon dividends being paid by the company. Relying on declared dividends alone as a means of generating income from a share portfolio is limiting for a number of reasons, including the following:

• Not all listed shares pay dividends, and in fact many of the most widely held stocks pay dividends that are negligible compared to the companies’ share price.

• For those shares which do pay dividends they are generally paid either annually or biannually. For investors who are wishing to extract more regular income from their portfolio this is probably not acceptable.

• There is no certainty regarding the likely size of upcoming dividends. A company may choose to suspend payment of a dividend for a plethora of reasons at any time.

Whilst dividend income is a welcome benefit of share ownership, many investors are not aware that there is another means to generate income from their holdings.

For shares for which there is an Exchange Traded Options (ETO) market it is possible to sell call options against share holdings to generate additional income. Not all shares listed on the ASX have an associated ETO market, but for those which do (which includes most blue chip shares) the ability to sell call options can potentially provide a lucrative income stream. A trader or investor who sells call options against their shares is engaging in a strategy called “Covered Call” or “Buy and Write”.

The owner of a call option has the right (but not the obligation) to purchase the underlying share at a pre-arranged price (known as the strike price) on or before a particular date (known as the expiry date). The buyer of a call option pays the seller of the option a fraction of the price of the share (called a premium) to secure this right. A trader or investor may buy a call option to speculate upon an anticipated increase in a share price, or to provide certainty by locking in a purchase price to be paid at a future date.

A trader or investor selling a call option as part of a covered call strategy is essentially obligated to sell their shares at the strike price to the buyer of a call option who may decide that they wish to exercise their option. The buyer of a call option will generally exercise this option only when the share price is above the strike price of the call option.

One of the disadvantages of the covered call strategy is that because the seller of an option is undertaking to sell their shares at the strike price they are unable to participate in any unexpected appreciation of the share price above the strike price of the sold call.

One of the benefits of the covered call strategy is that the seller of the option is always in a better position than he/she would have been if the share price stays the same or falls prior to expiry.

The covered call strategy can allow an investor to generate a monthly income stream from their share holdings and can help the investor partially reduce the downside risk on their holdings simply by committing to sell their holdings at an agreed price.
The covered call strategy can also be traded on a margin lending account. By selling call options against holdings purchased on margin the investor utilizing a covered call strategy can in some cases generate income in excess of the interest costs incurred.

To open an account to trade COVERED CALLS follow this link and register your interest to open a Trading Account with our Preferred and Recommended Alliance Partner.

IMPORTANT
This document has been prepared without consideration of your specific investment objective. You must therefore assess whether it is appropriate, in the light of your own individual objectives, financial situation or needs, to act upon this information. While this document is based on information from sources which are considered reliable, Tangible Assets Financial Services, its directors and employees do not represent, warrant or guarantee, expressly or impliedly, that the information contained in this document is complete or accurate. Nor does Tangible Assets Financial Services accept any responsibility to inform you of any matter that subsequently comes to its notice, which may affect any of the information contained in this document. This document is a private communication to clients and is not intended for public circulation or for the use on any third party, without the prior approval of Tangible Assets Financial Services. AFSL 309666