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A covered call strategy is an approach for traders who own an underlying asset. The method allows them to make a profit when the underlying asset's market price goes up moderately and to buffer losses if market prices go down. The strategy limits profits to only what is gained on paper plus any premiums earned. Loss potential is the same for any investor holding the underlying asset, but traders who leverage their assets by using a covered call strategy can cushion shortfalls in their portfolio. Definition of OTM and ITM for Covered Calls There are two ways to define the relationship between an option's strike price and the market price of its underlying asset. Understanding the differences between the terms is important because the risks involved in implementing a covered call strategy depend on these terms at the time of writing the option. OTM - Out of The Money: The underlying asset's market price is less than option's strike price. Example: - Call Option XYZJan55 (strike price $55) - XYZ is trading at $50 ITM - In The Money: The underlying asset's market price is more than option's strike price. Example: - Call Option XYZJan45 (strike price $40) - XYZ is trading at $50 How to Implement a Covered Call Strategy (OTM) XYZ is trading at $50 (market price) 1) Trader buys 100 XYZ shares for $5000 (100 x $50 share cost)). 2) Trader writes (sells) the option: XYZJan55($2) - 100 shares of XYZ stock - Strike Price $55 (OTM), expiring in 30 days - Premium Cost of $2 3) Trader receives $200 from the buyer (100 x $2 (premium cost)). Total Investment cost: $4800 ($5000-$200) Result one: XYZ hits $57 (ITM). The call buyer exercises the option to buy 100 shares at $55. The call seller sells his or her 100 shares and receives at $5500, for a total profit of $700 ($5500 received from buyer - $4800 total investment cost). Result two: XYZ hits $43 (OTM). The call buyer lets the contract expire. In this example, the option seller would keep the asset and the $200 in premiums, but would suffer a $700 loss on paper ($4300 asset's worth -$5000 paid). The total loss reduces to $500 when adding the premium. Advantage and Disadvantage of a Covered Call Strategy: Pluses: The upside to this type of strategy is that traders get to earn a premium on top of any paper gain their from owned assets. Another advantage to the covered call strategy is that premiums can reduce any loss incurred from a decline in the underlying asset's market price. Minuses: The downside to implementing a covered call strategy is that a trader's profits are limited to only the gain on paper plus the premiums received from the call buyer. The investor can not receive any future profits from gains the underlying asset's market price because he or she would have sold the asset upon assignment. Examples of Implementing a Covered Call Strategy ITM: In the example above the investor sold the call OTM. Traders can choose to write an option at ITM, which will give them more leverage against declining market prices. Example: XYZ is trading at $50 (market price) 1) Trader buys 100 XYZ shares for $5000 (100 x $50 share cost)). 2) Trader writes (sells) the option: XYZJan45($8) - 100 shares of XYZ stock - Strike Price $45 (ITM), expiring in 30 days - Premium Cost of $8 3) Trader receives $800 from the buyer (100 x $8 (premium cost)). Total Investment cost: $4200 ($5000-$800) Result: The trader's profits are reduced if the option expires ITM, but his or her losses also reduce if the underlying asset's market price falls, providing an $800 cushion instead of $200, compared to the example above.

What is a protective put? A protective put is as its name implies, a form of insurance to protect a long position held in a stock. Buying a protective put insures the stockholder a maximum loss of the put's strike price. For example (see diagram) if the shareholder has 100 shares of stock ABC with a share price of $52, then a contract (1 contract=100 shares) can be purchased to limit losses at the strike price of the option. Let's say the option strike price is $50, then the maximum loss per share is $2 plus the premium paid (the cost of purchasing a contract). Let's say the premium for a contract is $2 (1 contract =100 shares=$200), then the maximum loss in the trade is $400. On the other hand, the profit potential is unlimited if the share price goes up and the only loss is that of the premium paid of $200. If the stock reaches $54, then the shareholder has broke even in the trade and realizes only profit as the stock goes up. So the key aspect of the protective put is that it minimizes loss in the case of a bad earnings report, share dilution, etc. Are protective puts a valid strategy? Some would say that buying protective puts is not a good strategy for the risk averse. The argument here is that the risk averse should stay away from stocks altogether and focus on less risky instruments such as bonds. However, for the astute investor, protective puts can provide a useful tool, for example, during times of higher risk such as right before an earnings report is announced, or just prior to a FDA announcement on drug approval. If premiums are purchased just before news and just before the front month expiration, the loss incurred will be minimal if the stock averts disaster and heads skyward. It is good to think of options in this sense like any other type of insurance (car insurance, homeowner's insurance, etc.). It seems like a waste of money if there aren't any problems, but if there are, you are glad you have it. Types of stocks to consider a put strategy in The types of stocks that are the best to use the protective put strategy on are highly volatile stocks with extreme amounts of upside and downside. The best example that comes to mind are small biotech stocks in which the success or failure of the company relies on a binary yes/no decision by the FDA. If the drug is accepted, then the stock often skyrockets, but if it fails these stocks can almost go to zero overnight. In this case a great strategy is to buy the stock and protective puts immediately before the announcement and if approval is won, the loss of the premium paid will seem like nothing compared to the extreme amount of profits that are possible. Other types of stocks that can work well with this investment strategy include other small cap stocks, volatile ETFs and index funds that commonly exhibit large price changes. Stocks to stay away from with this strategy would be large, stable blue chip stocks that are typically much less volatile. Paying for protective puts in the case of these stocks is much more likely to result in futile expiration and loss of the premium.

A call order is one of two types of orders that an option trader can make (the other being a put order). The trader can either choose to buy a call option or sell one. Buyer: The call option buyer has the right to buy the underlying asset, but is in no way obligated to do so. The call option buyer can choose to either exercise his right to buy on or before the call option's strike date, or they can let the option expire. Seller: The call option seller (writer) has the obligation to sell the underlying asset at its strike price, if a buyer exercises their right on or before the option's expiration date. The seller receives a premium (option market price) from the buyer for taking this risk. Both buying and selling call options are high-risk investments, with traders who buy taking the higher gamble. A trader may ask, if call options are so risky, why do investors buy and sell them? The answer is in the return, because even though the risk is high, call options can give investors high profits when performed correctly. What Is a Call Option? A call option is a contract that's connected to an underlying asset, normally a stock or commodity. Every call option contract has a fixed price (strike price) that each trader must honor on or before a fixed date (strike date). The terms and responsibilities under the contract differ depending on whether the trader is the buyer or the seller. Buying a Call Traders who buy call options are betting that the market price of the underlying asset will go up. Call options carry a premium, which varies depending on price and how close the purchase is from the strike date. Usually, one call option contract gives the buyer the right to buy 100 shares of the underlying asset. A call buyer pays a premium for each share covered under the call contract. If the asset's market price exceeds the call option's strike price, the call buyer will exercise his right to buy the shares. If the market price is lower, they will just let the option expire, resulting in a loss in whatever they paid in premiums. Example: GE is trading at $48 (market price) 1) Option Available: GEJan50($5) = 100 shares of GE stock at $50/per share(strike price), expiring on 1/15 (strike date) with a premium cost of $5. 2) Call buyer has $5500 in their investment account. 3) Trader buys 1 call option at $500 (100 x $5 (premium cost)). Result one: GE hits $70. The call option buyer exercises their right to buy 100 shares at $50. Their total investment is $5,500 ($5000 shares + $500 premium). They immediately sell their 100 shares for $7000, resulting in $1500 profit (300%). Result two: GE hits $30. The call option buyer lets the contract expire, does not exercise their right to buy and loses the amount of premiums paid. In this example, the option buyer would lose $500. Selling a Call Traders who sell call options are betting that the market price of the underlying asset will go down. Call options carry a premium that goes directly to the seller. If a call buyer does not exercise their option, the call seller keeps both the asset and the premium. On the contrary, call option buyers who exercise the option, obligate the call seller to sell the underlying asset. There are two types of call sales. A covered call is a sale in which the seller actually owns the asset. Traders make naked calls when they do not own the underlying asset. Naked calls have the highest risk and only expert traders should carry out this kind of strategy. Covered Call A covered call is a win-win strategy for traders who have the capital to own the underlying asset. Covered call sellers make a profit when the market price goes up and buffer losses when it goes down, by writing the call option with a strike price higher than its market price. Example: GE is trading at $50 (market price) 1) Call seller has $5000 in their investment account and buys 100 shares of GE. 2) Call seller writes the option: GEJan52($2) = 100 shares of GE stock at $52/per share(strike price), expiring on 1/15 (strike date) with a premium cost of $2. 3) Call buyer buys the option and call seller receives $200 in premiums. Result one: GE hits $70. The call option buyer exercises their right to buy 100 shares at $52. The call seller sells at $5200 and receives $400 profit ($200 in premiums + $200 from price) Result two: GE hits $40. The call option buyer lets the contract expire. In this example, the option seller would keep the asset, keep $200 in premiums, but would suffer a $1000 loss from the asset's current market price. The total loss reduces to $800 when adding the premium. Naked Call Options This type of call option is one of the highest risks a trader can make. It involves writing a call on an asset that is not owned. The naked call writer will need to buy shares if the call buyer exercises the option. Example: GE is trading at $50 (market price) 1) Call seller writes the option: GEJan52($2) = 100 shares of GE stock at $52/per share(strike price), expiring on 1/15 (strike date) with a premium cost of $5. 2) Call buyer buys the option and call seller receives $500 in premiums. Result one: GE hits $70. The call option buyer exercises their right to buy 100 shares at $52. The call seller needs to buy 100 shares to cover the option and pays $7,000. They deliver the shares and receive $5,200 from the call buyer, resulting in a loss of $1,800. The total loss reduces to $1,200 when adding the premiums received at the beginning of the sale. Result two: GE hits $40. The call option buyer lets the contract expire. In this example, the option seller would keep the asset, and make $500 in profit from premiums. The lower a naked call seller's strike price deviates from the asset's market price, the higher premium the seller will receive, but if the buyer exercises the option, total loss also increases. NEXT: [thread=11599]Put Option[/thread]

To trade options, an investor must open an account with a brokerage house that has a seat on the trading floor of an option exchange. Traders can choose to open their account with a personal (full-service) broker, online (discount) broker or a broker that offers both services. Personal brokers offer traders more help, but they charge more in commissions and fees. Online brokers are cheaper but they only offer limited support. Some brokers offer both full and discount service, giving the trader a choice when placing their orders. A broker's quality of service depends on the broker themselves and varies throughout the industry. Personal Brokers Traders use a personal broker when they seek financial advice or need a human being to place a buy or sell order for them. Most traders do business with personal brokers by telephone. Personal brokers can guide an investor, who is new at trading options, in placing their orders correctly. They also can give a trader advice before placing orders, and they can help a trader come up with an investment strategy that fits their needs. Personal brokers charge three to five times more in commissions and fees than online brokers. Personal brokers are useful when traders do not have a computer or an internet connection available to place an order. Online Brokers Traders familiar or comfortable with option trading can place orders themselves using an online broker. Sometimes called home broker, this system provides a direct link between the options trader and the exchange floor when executing their buy and sell orders. The home broker is a do-it-yourself type system that does not give traders financial advice, but rather provides the tools for traders to find the information on their own. Discount brokers build a variety of tools into their home broker systems, which include real-time streaming, order entry windows, historical financial data indexes and real-time graphic analysis. Order execution speed and online sever availability depend on the chosen discount broker's quality of service. Broker Fees and Commissions All brokers, both personal and discount, charge commission fees. Traders add these fees into buying costs and deduct them from their profits. In other words, each time a trader places an order or uses personal broker services, the brokerage house charges a fee. A trader should consider commission fees when developing their investment strategies. Is Cheaper Better? Most traders think that the best option broker is the one that charges the lowest commission fees. Lower fees are great when an investor works with low margins, but they are worthless if the broker's quality of service is inferior. When finding the best options broker, traders should consider other factors that affect order handling, including server capability, speed of order transmission to the exchange floor and the overall user experience of the broker's online ordering system. Server Availability Online brokers use servers to handle their online traffic. Some servers are larger than others, and the home broker's service availability depends on the brokerage house's infrastructure. Low broker fees are not an advantage if the trader cannot place their orders when they want. Home Broker User Experience Traders need to place their orders fast and easy. Their home broker system should be easy to use, simple and straightforward. The system should offer the trader a single order entry window that gives them alternatives in placing their orders, which include placing stop orders, short selling, placing market orders, covering calls and placing limit orders. Order Execution Traders who buy and sell orders need their orders to execute. Once executed, the trader needs to feel at ease that their broker will guarantee the price executed on the order. Some home brokers do not guarantee that executed orders will have the best available bid-ask price available. The National Best Bid or Offer (NBBO) requires brokers to meet SEC requirements, which give traders the best-quality service. Options traders should look for discount brokers that exceed NBBO standards. NEXT: [thread=11554]Options Chains[/thread]

A margin requirement is the minimum balance a broker house requires an investor to have in their account when writing call or put options. The requirements vary depending on the broker and the terms agreed upon when opening the account. Every bank account has a balance and the balance increases when the owner makes deposits and decreases with withdrawals taken from the account. Investment accounts act in the same way except traders call their account balance "margin," because their broker uses it as collateral to cover their trades. Option traders can sometimes borrow money from the brokerage house to increase their margins or cover orders when they are short on cash. Borrowed margins have even stricter requirements, cost more when adding interest charges and can be called sooner by the broker, if the investment loses significant value. How to Calculate Margin Every brokerage house has different margin requirements. In general, brokers only let traders write options on a 10%-20% margin (balance in the investment account). If the investment does well their margin increases. If the trade goes bad, the brokerage house sells the option (margin call). A margin call occurs the instant an option drops below the trader's margin requirement, covering the trade and minimizing loss. Margin requirements fluctuate as the market price moves up and down from the strike price and the requirement increases when short selling. Initial margin requirements are: 100% of option proceeds, plus 20% of underlying security value less out-of-the-money amount, if any minimum requirement is option proceeds plus 10% of the underlying security value proceeds received from sale of call(s) may be applied to the initial margin requirement after position is established,*ongoing maintenance margin requirement applies,*and an increase*(or*decrease) in the margin required is possible For simplicity, assume that GE's market price is at $20 in all the examples below. Selling a Call (Shorting) Example 1) Investor wants to sell (write) 10 GE-January call options, expiring on 02/15 with a strike price of $20 for $1 Result: The option trader would need 20% of the total market value of the securities in case the buyer chooses to exercise the option. This amount works out to $5,000 but since he was paid $1,000 for this option the trader only needs $4,000 in his account to place this call order. Selling a Put (Shorting) Example 1) Investor wants to sell (write) 10 GE-January put options, expiring on 02/15 with a strike price of $20. (Symbol: GE JAN20). Result: Again, the option trader would need 20% of the total market value of the securities in case the buyer chooses to exercise the option. This amount works out to $5,000 but since he was paid $1,000 for this option the trader only needs $4,000 in his account to place this call order. Borrowing on Margin Sometimes an investor needs more money to make a trade. When the trader has a good credit standing, they can ask their broker to lend them the funds needed to place an order. The broker house charges interest on top of the loan. Profits from borrowing on margins decrease significantly because the trader splits gains with the broker house. The borrower's risk also increases because the broker house will always get paid back, if the investment goes bad. Example 1) Call option available: 10 GE-January call options, expiring on 02/15 with a strike price of $20, and premium of $2. (Symbol: GE JAN20) 2) Investor wants to buy 10 call options at $2 = $2,000. 3) Investor only has $1,000 on margin and asks his broker to lend them $1,000 at 5% interest. Result: The margin requirement is $1,000. If the option's market value decreases $1,000, the broker will call the option and sell it immediately to cover the loan. The investor's account will hit $0, and they will need to deposit more funds to make future trades and to pay interest due to the broker. Margin Calculator Provided by CBOE is this useful online tool that calculates the exact margin requirements for a particular trade. NEXT: See our Options Forum

I came across this guide, 25 Free Options Strategies from the CME Group, http://bit.ly/nnqDEC Has anyone used it?

I have experience with pair trading, but I heard some online companies now allow you to trade Pair Options. If anyone knows where I can trade Pair options please let me know? :cheers: