Covered Call Option Strategy Explained For Beginners

how to use call options to generate passive income we're gonna be going over the most basic call options strategy known as covered calls I'm gonna be speaking to you as if you know nothing about call options or covered calls so let's begin this is gonna be an unedited unscripted so please bear with me and we're going to be doing this as if you were buying the call options from me so this is the transaction with me and use so let's begin let's say I buy JP Morgan stock so JP n I bought JP m and how do I want to make money off JP n well first I want the price of the stock to go up so I want to make money through price appreciation secondly if this company pays a dividend which it does then I want to make money with dividend income which it will and thirdly I want to make money with covered calls and I'm gonna show you how let's say the current price of JP m so let's say current price let's say the current price is $100 and let's just say albright let's write it here 105 let's say I will sell you the option to buy my stock from me at the price of 105 dollars within the next 30 days so that's the expiration date and in order for you to have that option to do so I'm going to charge you two bucks so you're gonna pay two dollars for that option so don't get overwhelmed we're gonna break this down piece by piece again to summarize the current price of JPMorgan stock is $100 I am giving you the option to buy this stock from me for a hundred and five dollars within the next 30 days and for you to have that option it's gonna cost you two bucks from your perspective as you the person buying that call option from me what do you want the price of JP Morgan to do you want it to skyrocket I'll show you why let's say it goes up to $120 if the stock of JP Morgan goes up to $120 then you have the option to buy my stock JP Morgan stock from me at the price of one hundred and five dollars if that's the case that you would buy my stock for me at 105 and then you would just instantly sell it at 120 in that case you make a gain of $15 minus the $2 you paid me for that option so you would be up $13 now let me get rid of this so we don't get confused so that's from your perspective let's see it from my perspective the person writing the call option doing the covered call remember I bought this stock for $100 and let's go over the scenarios of what happens in each scenario because there's many ways that you can win that I can win in the situation let's say the stock price at JPMorgan Falls to $90 I bought it for a hundred it fell to $90 let's say on the 29th their 30th day so basically the option the timeframe is expiring the stock price fell to 90 if this is the case would you want to exercise the option would you want to use that option to buy this stock for me at $105 absolutely not because you can just go onto the stock market and you can buy JP morgan stock for $90 so why would you want to buy JP Morgan stock from me at $105 when you can buy for 90 this is a situation where the option that you have is expiring worthless it's out of the money it's not in the money from my perspective this is great because I just made two dollars from the option I sold you which is expiring worthless unfortunately the stock fell ten dollars in value but at least I made sue bucks so I'm down a net eight dollars that's the situation where the stock price falls let's say the stock price does nothing it's the same thing after 30 days let's see the stock price is the same it's a hundred dollars in that case why would you want to exercise the option and pay a hundred and five dollars to buy me buy from me JPMorgan stock when you can just go onto the stock market and buy for a hundred bucks so no one in the right mind would exercise this option and buy it from me for 105 when it's worth 100 in that case it's the same thing I'm gonna pocket to two dollars for the option I sold you and expired worthless in this case through price appreciation I didn't make money I didn't lose money but I pocketed two bucks so I made money on the options premium okay let's say the third example let's say the price I bought it for a hundred dollars and after 30 days the price is 104 dollars in this case again why would you want to buy my stock from me for $105 when you can buy it on the open market for 104 in this example your option is going to expire worthless because you can buy a cheaper on the open market rather than exercising your option and buying it from me for 105 so in this case what happened from my perspective this is great because I mean for bucks buy the stock going up and I also made two dollars from the options contract that I sold you that expired worthless so let me get rid of this okay so here's the downside from my perspective let's say the stock does go up to $120 this is the worst case scenario for me because what happens here is that I bought it for $100 but the stock price shot to 120 if I did not have if I did not if I did not write this call option that I would have been up 20 bucks and that would have been awesome however now I am limiting myself I'm limiting my games to 105 plus the options contract in this case the stock price went up to 120 but I am forced to allow you to buy it from me so I need to sell it at 105 in other words I need to sell it for 105 so I make $5 from the price appreciation and I make $2 from the contract price that I sold it to you for so in this case I made $7 when I really could have made 20 so by doing this covered call strategy you're limiting your upside potential however the question is would you be upset if this scenario panned out because you made five bucks on the price appreciation and you got money off the options contract so I mean yeah I guess you could have optimally speaking you could have made twenty bucks but I don't know if that would allow you to complain because you made money both ways so that is how options contracts work with call options and covered calls I hope this helps if you have not done so already please check out our other investing videos we have a great video library investing for beginners people who are new to the stock market and also intermediate level stock as well and you can also follow our stock accounts what we are doing with our hundred dollar portfolio our five hundred dollar portfolio and our $100,000 portfolio if you haven't done so already please subscribe and I will see you in the next video thanks so much and take care

Channel: ClearValue Tax

Views: 168,116

Keywords: call options, covered calls, options, options trading, investing in options, options explained, stock options, call options explained, how to trade options, options for beginners, call options example, call options robinhood, stock market investing tips for beginners, investing tips, investing tips for beginners, investing for beginners, investing advice beginners, stock market, stock market beginners, investing 101, covered call option strategy, covered call option

Id: hbLp63AOceo

Length: 9min 45sec (585 seconds)

Published: Thu Jun 18 2020