Covered calls are a popular investment strategy that traders and investors use to find opportunities for their stock holdings. This trading strategy involves buying shares of stock and then selling call options on those shares to create a steady income stream.
At its core, the covered call strategy is relatively simple. Traders who use this strategy buy stocks they believe will rise over time and then sell call options on those stocks to collect any returns. When done correctly, this investment can effectively do well and take advantage of any potential gains in stock value over time.
How to use a covered call
Many different factors go into successfully implementing this strategy. The first step is choosing the right stocks to buy. Some traders look for companies with a history of stable growth and predictable earnings, as these can often be more reliable investments than other, riskier stocks.
Once you’ve identified the right stock to invest in, the next step is choosing when and how to sell call options on those shares. Many traders will hold on to their stock until it reaches a specific price, then sell the call option at a predetermined percentage above that amount.
For example, if you’ve purchased $10,000 worth of stock with an underlying value of $5 per share and decide to sell one call option at $6 per share, your potential result from this strategy would be $1 per share if the stock rises in value over time.
Other trading factors to consider when implementing a covered call strategy are choosing a strike price slightly higher than your target selling price to ensure that your call option has some value if the stock doesn’t rise as expected.
Suppose you’re using this strategy to identify opportunities for an existing portfolio. In that case, it’s essential to keep track of the risks associated with selling calls and ensure that you don’t risk losing more money than you’re willing or able to.
Why you should trade on a demo account before using covered calls
If you’re new to trading and want to try this strategy, starting with a demo account is a good idea. This approach will allow you to get familiar with all the ins and outs of the trade, including any potential risks involved, without risking any actual capital.
Many online brokers like Saxo Bank offer free demo accounts to help you get started with a covered call strategy. With these accounts, you can practice different trading strategies and learn how to manage risk effectively before jumping in with your own money.
What other strategies can be used when trading in the UK?
Many different trading strategies can be used in the UK, from more conservative approaches like covered calls to more aggressive strategies like day trading or high-frequency trading.
Some of the most popular strategies for UK traders include technical analysis, which uses past market data to make predictions about future price movements, and fundamental analysis, which focuses on macroeconomic trends and company-specific news to inform investment decisions.
Other popular strategies include swing trading and position trading. These involve holding positions longer than one day and generally rely on a combination of technical and fundamental analysis techniques.
Straddles and strangles are also commonly used by UK traders. These strategies involve buying both call and put options on the same stock to make good use of any expected price movements in either direction.
Fundamental analysis is often used with technical analysis strategies, such as trend following and oscillators, to create well-balanced trading portfolios.
The bottom line
Whether you use a more conservative strategy like a covered call or an aggressive approach like day trading, there are many effective ways to trade successfully in the UK. Overall, the covered call strategy effectively allows traders and investors to boost the value of their stock holdings. By following some basic guidelines and carefully managing risks, you can use this strategy to boost returns while limiting any potential downturns.