How to Sell Covered Calls for the Complete Beginner!

did you know there is a very simple and straightforward way to generate thousands of dollars thousands every month in cash flow from your Investment Portfolio it doesn't matter if you prefer to own index funds like the S&P 500 growth stocks such as Apple or Google and even dividend stocks such as 3M Coca-Cola or even Proctor and Gamble this method of generating cash flow is known as selling covered calls this video is designed for the complete beginner investor who wants to generate cash flow from their portfolio and either knows absolutely nothing about covered calls and it's also for investors whose blood pressure increases every time somebody uses the word options in a sentence we're going to cover everything you need to know to get started we'll talk about what call options actually are how to sell a covered call how to read an option chain how to pick the right option to sell and we will jump into my own portfolio and sell a covered call together in this video that's a lot to cover so let's not waste any time let's Jump Right [Music] In we are starting from the beginning here so what exactly is a call option at its core it's a bet there is a buyer and there's a seller the buyer of the option pays money to the seller of the option this is no different than what occurs when you buy insurance when you go out and buy auto insurance you are buying insurance and the insurance company is selling Insurance in exchange for the possible benefit in the future you pay the insurance company a premium this contract obligates the insurance company to provide a benefit in specific situations sticking with this insurance example let's say you buy an auto insurance policy with a 12-month term that costs you $11,000 your insurance policy protects you against certain events that might occur to your vehicle including auto theft a rock hitting your windshield a car crash that puts people in the hospital Etc in this situation the insurance company is betting that the actual cost of insuring your vehicle or any of these events will be less than $1,000 in the year and in exchange you have peace of mind as the buyer of the insurance that your vehicle is protected so let's transition back to stocks if you happen to be the buyer of a call option you are betting that the price of a stock will be above a specific price in the future if you are buying an option that means somebody is selling you the option every transaction must have both a buyer and a seller or no contract is created the seller of the option contract in this scenario is betting that the price of a stock will be lower than a specific price in the future this price is known as the strike price to make sure we are on the same page let's look at all of the specific terms involved this is known as an option chain you can think of it as the options Marketplace it lets you know what the going price is for all of the different option contracts currently available to be bought or sold every brokerage has a slightly different look to the option chain but the information presented is all the same the left side of the option chain is for call options and the right side is for put options the options Marketplace is first distinguished by when the option expires some stocks only have one contract expiration every month which would usually be the third Friday of every month more popular and highly traded Investments might have weekly stock option contracts that expire every Friday with certain exchang traded funds you even have three different expiration dates every week on Monday Wednesday and Friday with Fidelity these expiration dates are shown right here next option contracts are separated by different strike prices the strike price shown right here is the price at which the option contract can be exercised by the option buyer then we have the bid and the ask price the bid is the highest price that somebody is willing to pay and the ask price is the lowest price that a seller is willing to sell for these numbers right here are based on one share but it's important to note that every option contract is for 100 shares not just one share what this means is the total price for an option would be this figure multiplied by 100 from this point forward we are talking exclusively about selling options because this is is how we are generating cash flow specifically we are talking about selling call options when we sell a call option we are now under the obligation to sell 100 shares of the stock to the option buyer at whatever the strike price is in the future if the price is at or above the strike price let's look at an example let's look at Apple Incorporated AAP is the ticker symbol the current price is $140.9 per share let's say you think the price of Apple will be below $150 over the next 26 days we are looking at the option chain for Apple which expires on November 4th 2022 which is in 26 days if we look at the option chain we can identify the strike price $150 right here the bid for this contract is $258 and the ask is $266 let's assume that an agreed upon contract would be right in the middle at $262 to get the full price we would take $262 * 100 which equals 26 $62 if you wanted to buy this option it would cost you $262 and if you wanted to sell this option you would receive $262 and if you sold this option you would immediately receive the $262 in your brokerage account what would happen next depends on what happens with the price of Apple stock if the stock price is below $150 per share at the end of business on November 4th the option contract would be completely worthless to the buyer as the seller of the option you would keep every bit of the option premum paid to you and you would be under no obligation any longer if the stock price is above $150 per share then the option contract would be exercised the option buyer would be exercising their right to receive 100 shares of Apple stock at the strike price of $150 per share and you would be obligated to sell those 100 shares to the option buyer for $150 per share if shares for Apple are trading for $175 per share you still have to sell the shares for $150 per share the most logical question at this point point is where do I get the 100 shares of Apple stock so that I can sell them to the buyer well if you don't own any shares of Apple stock you have to go out into the marketplace buy 100 shares and then immediately sell them for $150 per share if the price of Apple is currently $175 per share this would mean you would need to go spend $17,500 to buy 100 shares and then immediately turn around and sell those 100 shares for only $115,000 this means you lock in a loss of $2,500 furthermore in this type of scenario the risk is unlimited you could have a crazy scenario where the stock stores buy much more than $25 per share in which case you could be locking in a loss of5 10 $15,000 even more the solution to this type of scenario is to already own the shares of the stock and completely avoid the risk of having to go out and buy shares in the open market my friends let me introduce you to the covered call what makes a covered call a covered call Simple you already own the shares you completely avoid the risk of having to buy shares at unpredictable prices in the future if for some reason the option gets exercised and you have to sell shares to the option buyer it's simple you just sell the shares you already own remember that every option contract is for 100 shares as a result to have a covered call you must have 100 shares of a stock before you can sell the call option now that we have the groundwork laid let's talk about some more details back to our option chain how do we decide which option contract to sell well it depends on what you are trying to accomplish we can see that the value of the option contract goes down the further away you get from the current market price this is because these option contracts are more and more likely to expire worthless for the borrower therefore they're worth less money it also appears that the lower the stock price the more value the option contract has as well however there is more that's going on here than meets the eye a call option contract with a strike price above the current market price is known as out of the money or otm whereas a call option contract with a strike price below the current market price is known as in the money or itm finally if the strike price matches the market price then this is known as at the money or ATM when we think about the value of an option why does an option contract that is currently out of the money such as a 26 Day Option with a $150 strike price and current market price of $140 have any value at all the answer is there are 26 days for the price of Apple stock to go up and past the strike price in other words there is time value built into the option otherwise it has no value right now every option contract's value is made up of either extrinsic value intrinsic value or a combination of both let's say you had already sold this option contract right here strike price $138 and a current market price of $140.9 this option contract is in the money by $2 and has both intrinsic value and extrinsic value to calculate the intrinsic value you simply take the the market price and subtract the strike price of the option in this case it would be $140.9 minus $138 equal $29 this is the intrinsic value of the option the remainder of the option's value is extrinsic value for this option the market price is approximately $8 this means the extrinsic value is $8 minus $29 equal $591 the marketplace in this scenario is essentially saying since there are 26 days left for the price of Apple to move up and Beyond its current price we place a value of $5.9 on this potential future value as the price of a stock changes so do all of these calculations when you sell a covered call option this option contract is viewable in your brokerage account just like this your cost basis also known as the amount you sold the option for is listed over here what's important to know about the option you sold is the value of this option is constantly changing after you sell it with a covered call option option the option goes up in value as the price of the underlying stock goes up in value and the option goes down in value if the price of the stock goes down in value once you have sold the covered call option one of three different things is going to happen to get rid of this option number one you hold the option all the way to option expiration and the option expires worthless to the buyer meaning you keep all of the option premium you initially received number two the option is exercised by the option buyer at some point between now and expiration you you should know that the option buyer can exercise the option at any time after they buy it from you and then number three you decide to close your option position early by buying the option back for either a gain or loss now this is where some people get confused so stick with me remember you opened this option position by first selling the option in order to close this option contract out you would need to do the opposite of what you did initially which means you would need to buy it back if the options value is now higher than what you sold it for then you're going to lose money if you buy it back however if you're able to buy the option back for less money than you originally sold it then you made money there are situations where an options value might go down by a significant amount to where it is worth only a fraction of what you sold it for maybe sold it for $100 and now you can buy it back for only $5 most investors would recommend buying the option back at this point because you capture 95% of the profit and you are getting rid of any future obligation on the stock now that we have a pretty basic understanding let's go into my own brokerage account and sell a new covered call on an existing dividend stock in my own portfolio all right guys we're in my brokerage account and one of my sub accounts and it's time to take a look at a specific order and to do that we're going to take a look at Starbucks Corporation sbux here's the option chain for Starbucks currently today it's up $247 a share which is 2.86% and I recently procured Starbucks at around the same price you look at the option CH here you'll notice there are a few indicators here which we want to be aware of first off any dividend payments coming up here right here you'll see the X dividend date is 119 you have to own it before this date occurs in order to receive the dividend and you've got earnings coming up which you definitely want to avoid trading through earnings you can maybe get away with before or far after but definitely you want to avoid trading through earnings unless you're a very lucky individual for here we're going to take a look at a Starbucks option a covered call we're going to take a look at we've got 1021 here which is 4 days out or we can go 11 days out so we're going to do it look at an outof the- money covered call option for Starbucks so we're going to go out 11 days now remember price $88 84 right here which means we want to sell right around a 20 to 25 Delta here so here are the strike prices right at the money is right here 8884 so right at $89 and let's go ahead and come up here we'll change it to 20 strikes so we can get further out of the money all right so here's our 20 Delta right around here $93 per share so in order for us to get assigned on this and have it exercised the stock would have to raise up and in the next 11 days from $88.75 up to $93 so that's a 21 Delta here we could go even more conservative and go to a 16 Delta but you'll notice right here at a 21 Delta just under just above 21 Delta the going rate for this is $58 here for the bid and $61 for the ask so we're going to go ahead and choose this option right here with a $93 strike and if we want to open up a new position we would click on the bid here which seems a little bit backward but we're going to sell to open remember we're selling to open and to close this position we would have to go buy to close sell to open we're going to sell one you'll see the bid here the ask right here and the midpoint so we're going to go ahead right at the midpoint we're going to click there it's a limit order meaning that it will not fill this order unless we actually get the price we want that'll be good for today only a limit of 59 so it's $583 um including a 65 C fee we'll go to preview order and we'll go ahead and place our order and right now the order is open right after I clicked here we went ahead and got filled on that position let me go ahead and go to our orders and now you can actually see this account you can see the position here here is the actual position that I own right here Starbucks 100 shares right here and you can see my paired covered call here Starbucks $93 call which expires on October 28th and for that we received $58 right here $58 31 now as I mentioned this price right here this $63 or last price 63 cents again times 100 this price is constantly changing depending on what the price of Starbucks is doing if Starbucks price is going up then this is going up in value if Starbucks price is going down then this price is going down as well and as an option seller we want this option price to go down in value because eventually if we want to close this position we actually need to buy to close the option if we're not going to just let it ride through expiration and let it expire worthless one thing that I also do when it comes to my covered calls is immediately once I have a new position I immediately open up a trade to close it if my price is reached usually for me it's a profit Target of 90% which means I would need this price here of the option to go down by 90% And then I would buy it back to close the position so if I purchased it for $58 we'll call it $60 to rounding which means that I would need this price to go down from 63 down to 6 cents before I would then close it so what we can do now is we can actually enter this trade we'll go here we will go buy to close and we will go good until canceled if it was just good for today then this order would get cancelled once the trading is over for the day so instead we would change it from time and force from day until good till canel we put our limit price in there of 0.6 meaning that from this point forward we would get an estimated profit of $52 if in fact we get this order filled at any point between now and expiration we went ahead and submitted that here and it's an open trade and it will stay open for the duration here until it actually gets met or the option gets assigned to me if the price continues to stay above 6 cents per share make sure to leave your two cents down in the comments Below on what you thought about this video have a great rest of your day and thanks for watching

Channel: The Average Joe Investor

Views: 85,390

Keywords: covered calls, covered calls explained, covered calls for income, covered calls fidelity, covered calls strategy, covered calls for beginners, covered calls on dividend stocks, covered calls options trading, covered calls in the money, covered calls startegy, covered calls for begginers, the average joe investor, the average joe investor cash flow, dividend stocks, dividend stocks 2022, covered calls for cashflow

Id: Feo5XeMKloQ

Length: 16min 16sec (976 seconds)

Published: Wed Oct 19 2022