As all good investors know, you don’t get any reward without taking a corresponding risk. So, what is the catch here — where is our risk?
The main risk that you face is from owning the shares in the first place. We all know, that shares can go down in value as well as up.
However, selling the call on the shares actually reduces the risk of simply holding the shares.
Selling Covered Calls Reduces the Risk
You have collected a 5p premium per share that’s yours to keep whatever happens. That can be offset against any drop in the value of the XYZ Plc shares. And the more iterations of call selling you go through, the larger the income you collect to help offset any drop in the share price.
The other risk is that the share price shoots way up. So, for example, if XYZ shares jump to 230p each by expiration day, your covered call means that you will be obligated to sell them at 210p each. Not the 230p you could get in the open market.
Of course, you would still make some profit on the shares and get to keep the premium and any dividends — so it’s hardly a bad outcome.
You are giving up some potential future upside in return for some definite income now. I think that’s a pretty good deal. After all, that extra income is yours to keep whatever happens.
If you are already a ‘buy and hold’ investor, then selling covered calls and their close cousins — cash secured puts — is a fantastic way to seriously boost your income whilst also reducing your downside risk and volatility. Done right, and with a reasonably sized account, it could even help you achieve your financial independence.