How to Turn Apple's Stock Into an Income Stream
When you write a covered call, you sell one call option for every 100 shares of a stock that you own. You can also execute a buy-write to establish a covered call. This simply means you open the long stock and short option leg of the trade at the same time in one transaction. In either case, you collect the premium, as a credit to your account, of the call you opted to sell. You keep that income no matter what happens. If the price of the stock moves past the strike price of the call you sold, you could have your shares called away by the party that is long the call you are short.
This all becomes clear as we look at an example.
Apple is an excellent stock to illustrate this strategy. If you own at least 100 shares of AAPL, you can generate some serious income from the position. Too many investors overlook the potential of this relatively simple method.
Prior to Apple's dazzling report on Tuesday, you might have decided to hedge your position just a bit by selling a covered call. On weakness in a long position, this is usually a sensible move. Like a dividend, covered call income helps offset any underperformance in the stock. With AAPL trading around $560 on Tuesday, you could have sold the AAPL May $600 call and collected about $9.90. That's $990 that you keep no matter what happens.
Imagine repeating that process on a monthly basis. That's an excellent supplemental income. For some, it represents a second income. For others, it could become the primary source. I know several folks with relatively large positions in AAPL who literally live off of covered call income, just as some investors pay expenses and such using dividends.
When you write a covered call, you always run the risk of losing your shares. This scares many investors. In some respects, it probably should. In the AAPL example, maybe you picked the $600 strike because you expected weakness, stagnation or only moderate upside in the stock post-earnings. Clearly, anybody who doubted Apple even a little this quarter was wrong (present company not excluded).
AAPL soared to $600 in after-hours trading. And chances are it will hover around that level or blast far past it between now and May's options expiration. But you will not necessarily lose your shares prior to expiration just because AAPL trades above $600. You could get them called away, but there's an equally as good, if not better chance, that you will not. If, however, AAPL trades above $600 at expiration, you are almost certain to have your shares called away. Brokerages automatically exercise an ITM option contract unless the contract owner instructs them otherwise.