This morning, I wrung a bit more income out of one of my stocks by selling covered calls. If you've ever played Cashflow 202, you probably have bought options - calls and puts. A call gives you the right to buy a stock at a certain price by a certain time. When you sell a covered call, you are selling someone the right to buy the stock from you for a certain price by a certain time. Covered means you actually own the stock that you might have to sell to the call buyer. (A naked call means you do not own the underlying shares, so if the call buyer wanted to exercise his option and buy the shares from you, you would first have to buy them from someone else. This is a fairly risky play because if the stock rises in value, you would have to pay more for them than what you agreed to sell them for.)
One of my favorite stocks is a real estate investment trust that trades under the symbol SFI. I've been a holder of this stock for 6 years and love the company. Their business is making loans on commercial properties across the country and because they are a REIT, they must pay out almost all of their profits to their shareholders each year in the form of dividends. Thus, this stock combines two of my favorite investing concepts: real estate and cash flow.
The stock is generally a non-volatile one. The price doesn't jump around too much, so options generally don't have a too attractive risk / reward ratio to me. However, I noticed the price has had a bit of a run-up lately, so I put in a limit order to sell some calls. This morning, that order was filled and I sold 5 March 17 calls with a strike price of 55 for $1.25 per share per contract. One contract is good to buy 100 shares of stock, so I've sold someone the right to buy 500 shares of SFI from me at $55 per share on or before March 17. For this right, they paid me $625, or $1.25 per share times 500 shares. If the stock price on March 17 is below $55 per share, their contract is worthless (since they can buy the shares on the open market for less). If it is above $55, then they can exercise their contract and I must sell them the shares at $55 per share. But because they have already paid me $1.25 per share for the option, I actually make $56.25 per share.
Obviously, I hope the price on March 17 is below $55, but even if it isn't, I'm not worried. It can go up to $56.25 and I still won't be losing money. And if I do have to sell, I plan on buying the shares back anyway, since I want to keep holding this stock in my portfolio.
The nice thing about this is that this is in my Roth IRA account, so all the money I get, both from regular dividends and from selling the options, is tax free!
Options on stocks are just like options to buy a piece of real estate. You collect a fee for giving the option buyer the right to buy your property within a certain amount of time. Just like in lease option deals, I hope the option buyer never exercises the option to buy because that nets me more money and I can turn around and sell someone else the option to buy, thus bringing in more income.
Note: This is not an offer to buy or sell any securities. Do your own due diligence. Figures do not include commission costs.