Everyone knows that it is a good idea to start investing for their retirement early on in life. As the stock market continues along its volatile path, however, investing in stocks is beginning to feel more like an act of faith than intelligent investing. In fact, over the past five years, hundreds of billions of dollars have been invested in secondary markets such as the bond and commodity markets, foreign markets, and precious metals simply to help reduce the up-and-down swings investors are experiencing.
The problem, however, is that even micro-managing an investment portfolio on a daily basis is no guarantee that earnings can be smoothed at all. As such, many investors have been left scratching their heads wondering what they should do next. One surprising idea is to start selling covered calls on stocks that the investor already owns.
Investing in options has always been viewed as a somewhat risky strategy by those outside the investing world. Some even refer to options trading as gambling, or betting, on the direction the market will take. While it is certainly true that some options traders try to time the market, writing covered calls is often thought of as one of the most conservative investment strategies available to the average investor.
In its most basic form, options are simply slips of paper that give one person the right to buy or sell an asset at a certain price on, or before, a certain date. While stocks are the most commonly traded asset, options can be written on anything from the price of crude oil to the price of a bushel of wheat. In exchange for selling another investor the right to buy an asset, the buyer pays the seller a cash premium. This premium income stays with the investor regardless of the direction that the price of the underlying asset takes.
When an investor writes a covered call, they are essentially selling an option on stock that they already own. The theory is that since they already own the stock, and have already assumed a certain amount of risk, they might as well try and squeeze a bit more profit from their stock positions. Many investors think of selling covered calls as renting their stocks to speculators.
As more than 85% of all options expire worthless, many investors feel that the additional income they earn from selling covered calls far exceeds any perceived risk.
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