April 7, 2006, Newsletter Issue #12: Generate income or lower breakeven
Tip of the Week
Another use of options is to generate income on stock positions already held, or to lower the breakeven on stock positions being purchased. This is done by selling an out-of-the-money call (this option has a strike price that is above the current stock price). When selling a call to open a position, you take on the obligation (if the buyer of the call exercises his right) to deliver the shares at a certain price (strike price) by a certain future date (expiration date). When selling options, you pocket the premium received from selling the option. When used in this manner, the owner of the stock sells calls because he thinks the stock will stagnate over the short term. The sold call generates income even if the stock fails to stage a rally.
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