If you (1) want to stay in the stock market, anticipating a rebound but (2) are nervous about the short-term outlook, you can sell call options on stocks you already own. This strategy, known as selling covered calls, provides portfolio protection and a chance to earn extra income.
You’ll receive a premium for selling the call, which is an option to buy your stock at a given price, within a certain time frame. Brokerage commissions are typically $25 for the first contract (100 shares) and then decline sharply, so it pays to sell calls against larger positions. If the stock doesn’t move or drops in price, you’ll keep the money as well as the stock. If the stock moves up the option may be exercised and the stock will be called away from you. Thus, one tactic is to sell calls with an exercise price slightly above the stock’s current selling price, building in a gain.
What if the underlying stock moves up in price? You can buy back the call, taking a tax loss on the option trade while retaining the stock for potential future appreciation.
