Covered Call Writing INTRO: Most of us have heard of the real estate situation whereby the seller gives a potential buyer an "option to buy" a piece of property. The buyer pays the seller a fee and if he doesn’t complete the purchase by a certain date he forfeits his fee and the deal is off. Bruce Hagan, Certified Financial Planner with RAI Investments is with us to explain a similar arrangement can be accomplished with stocks. Q1: If I own 100 shares of a stock can I give someone an option to buy it from me at a certain price? A1: You can accomplish this by selling to someone an option. These are standardized contracts that trade on an exchange. Not every stock has underlying options, but hundreds do. For example if you own 100 shares of xyz company and there are options available on that stock you can sell what is known as a call option on that stock. Q2: Can you go through an example of exactly how this would work? A2: Yes, Let’s say you wish to purchase the stock of xyz at its current market price of say $22. You might simultaneously sell a call option that allows someone to call the stock away from you and purchase it at $25 anytime between now and the third Friday in May. The buyer of the call option would pay you, let's say 2 points, or dollars per share right now for your option. If the stock trades above $25 you may have to sell your stock at $25. If by the stated time in May the option expires and you have kept the 2 dollars per share you were paid and continue to own the stock. Q3: Let’s say the stock goes to $30. I have to sell at $25? A3: If the stock goes above $25 and then comes back down below 25 you might not get exercised. But if the stock is above $25 at expiration date in May you will be exercised (or assigned) and will have to sell at $25. Let’s look at how you profit if that happens. You make $3 which is the difference between 22 and 25 plus the $2 option premium you received for a total profit of $5. Q4: What happens if the stock declines to say $19? A4: You won’t be assigned and you’ll continue to own the stock. However, instead of being down $3 you’re only down $1 because by taking in the $2 option premium you effectively lowered your cost basis from 22 to 20. Q5: It sounds like this is pretty conservative strategy? A5: It is conservative. Many people think of options as being very risky and indeed they are for the buyers of options. The sellers of options however are taking the opposite side of that transaction and really feed off the buyer’s greed. Regulators also clearly recognize the difference because buying options is not allowed in IRA accounts, but covered call writing ( This strategy we’ve described of owning stock and selling the option) is allowed. Q6: It sounds good, but don’t you limit your upside potential when you do this? A6: Yes, this is for the investor who is looking to step up to the plate and hit lots of singles and doubles, not the guy swinging for the fences. But very respectable returns may be obtained with less risk than just owning the stock outright. Q7: I would think this is more sophisticated than just buying stock. Should people try to do this on their own? A7: Not unless you’re really familiar with it. Work with a broker or financial planner who has earned the designation of "Registered Options Principal." The discussion offered above and in the movie should not be considered an endorsement by Florida State University. They are offered in the educational sense of providing thought-provoking information for our Web audience. Copyright shared with Florida News Channel (FNC), all rights reserved. Broadcast 1/14/2000