Selling Calls For Income
By Stock Options Channel Staff
If you understand the concept of placing a good-til-canceled limit order to sell a stock, then you are halfway to
understanding selling call options. This article will explain further.
Since 2003, our company has operated the stock picking discussion community ValueForumTM, where members gather each year for an event we call
InvestFestTM. Both online and at these events, stock options are consistently a topic of interest, and a
key strategy discussed is selling calls.
The best way we've found to explain the concept of selling call options to someone learning about them for the first
time, is to start with the notion of a stock you own that you are interested in selling if it should reach a higher
price. Perhaps the stock is trading at 9 and you might normally think about placing a good-til-canceled sell
order for that stock, at a limit price somewhat higher than where the stock is trading (perhaps around 10).
You might change your mind a few days later and cancel the order, but oftentimes that good-til-canceled order to sell
the stock would be left to either fill or expire at the date you designated. Imagine, however, that you were so sure
of the sell order that you would be willing to commit to leave it open for a month, maybe two months, maybe three,
maybe even a whole year? There are other market participants out there who are willing to pay you to make
that commitment, to them. In options jargon that payment is known as the "premium" and when you make the
commitment you enter into a "contract" essentially giving that other person the option to fill your sell order.
Entering into such a commitment for a specified period of time, to sell a certain amount of stock, at a certain price,
is essentially what "selling a call" means. You are entering into a commitment — a contract — and getting
paid for doing that. In options jargon, the pricepoint at which you commit to sell the stock is known as the "strike
Everything is standardized and organized in the options market, so for example you couldn't specify 258 shares at a
price of 9.99 and a date of next Tuesday, the way you could with a limit order to sell. You would only be able to use
100 share increments and only be able to choose from among the pre-specified expiration dates and strike prices
available. Typically there are available strike prices at every 1.00 increment or 2.50 increment, etc. all
depending on the particular stock. There are typically at least four different months out into the future to choose
from, and sometimes longer-term choices of a year or more as well.
All of this structure and organization delivers a very big advantage: all of the options contracts
are standardized. Let's examine what happens if you "sell to open" a call contract ("sell" because someone else is
paying for your commitment so they are the buyer and you are the seller, and "open" because you are entering into
— opening — an agreement, a contract with that buyer). Suppose the strike price is 10.00, the
expiration month is three months away, and you committed to sell 100 shares (equal to 1 contract, because the standard
in the options market is for each contract to represent 100 shares, the minimum increment). If your friend does the
same exact thing, your two contracts are no different from one another, and in fact no different from the contracts
created by any other market participant who picked that same strike price and that expiration month. The total of all
existing contracts at a given strike price and expiration month is known as the "open interest" for that call
That brings us to the benefit, the advantage of all this standardization and organization. Market
participants can pair up with anyone in the world, without even knowing who is on the other side of the trade or
whether they are opening or closing their position — you are blind to all of this, just the same way you don't
know anything about who is on the other side of the trade when you buy or sell a stock. This creates the
framework for a high volume marketplace and means the interested parties don't have to work to seek each other out,
because anybody with the right kind of brokerage account can participate.
This means, for example, that if you change your mind a few days later, you can "buy to close" the call options you
sold, and you might actually be buying those contracts from a different person than the one you sold to originally.
Going back to the example from the beginning of this article, that would accomplish the same thing as canceling your
limit order to sell, in other words your commitment to sell the stock has been crossed out.
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