Using Covered Calls to Derive Income From Pacific Drillinghttp://www.fool.com/investing/options/2014/01/21/covered-call-options-can-be-used-to-derive-incom-2.aspx Daniel Gibbs
January 21, 2014
One strategy that all investors should be aware of, even if they never use it, is writing covered calls. The use of this strategy can significantly boost investment returns, particularly in flat or declining markets, and can also allow an investor to derive income from a non-dividend paying stock. This can be very important for individuals that depend on their investments to meet their income needs, such as retirees. It is this second use for this strategy that this article is primarily concerned with.
What is a covered call?
The option seller is essentially making the opposite bet. Since the seller of the option gets to keep the premium regardless of what happens, the seller will earn a profit if the specified stock does not go higher than the strike price by the date that the option expires.
The seller of an option is also known as the option writer. Therefore, as could be inferred, the covered call writing strategy is based on selling options. But, what about the "covered" part? That is the integral second part of this strategy. This means that the call writer already owns enough shares of the specified stock to meet the demands of the option buyer should the call option be exercised. For example, if the buyer has the right to buy 100 shares of the specified stock from the seller then the seller will already own 100 shares of the stock that could be immediately sold to the buyer should the buyer exercise (use) the option. This substantially reduces risk since the option writer would otherwise have to buy the shares at a possibly substantially higher price than what the buyer is paying in the event of option execution.
How to derive artificial dividends from a non-dividend paying stock
This chart shows the current prices and volumes for the Pacific Drilling April 2014 options which expire on April 19, 2014:
The price that is most important to option writers is the bid price, as this is the price that market makers are willing to pay for the option. As the chart shows, the bid price on the $12.50 strike price option is $0.10. This option would give the buyer the right to buy shares of Pacific Drilling for $12.50 a piece between today and April 19.
There are a few nuances here that are common to all option contracts that are important to consider. First, each of these options is for 100 shares of stock. Therefo