Forget "Free" Income: The True Cost of Covered Calls

This options strategy can generate income, but never forget that there's a tradeoff.

Jan 26, 2014 at 1:02PM

Many investors are struggling to find the income they need from their investment portfolios. One options strategy promises to deliver more income to stock investors, but claims that using covered calls produces "free" income are misleading at best.

In the following video, Dan Caplinger, The Motley Fool's director of investment planning, goes through how covered calls work and what the trade-offs are. Dan notes that writing covered calls can indeed generate more income from your stock portfolio. But he also describes how in rapidly rising markets, the risk of covered calls is that you'll be forced to sell your stock for less than it's worth at that time, missing out on gains far in excess of what you received in exchange for writing the covered call. Dan points to recent experiences with Netflix (NASDAQ:NFLX), Boeing (NYSE:BA), and Celgene (NASDAQ:CELG) as examples of high-flying stocks that left covered-call investors wishing they hadn't used the strategy. Dan concludes that covered calls aren't a bad strategy, but you do have to know the risks and rewards involved.

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Fool contributor Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Celgene and Netflix and owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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