Let’s say that I own 10 shares of a particular stock which is currently priced at $100. (Note: Options are always 100 shares per contract, but for convenience, I’m using a smaller number). If I want, I can sell a call option contract at the strike price of $110 to someone else for $20 (10 shares x $2). Since I own the shares to back up this contract, it’s referred to as a ‘covered call’.
Now you might be asking yourself, what happens in a week if the stock drops? Like any other business deal, you are either going to lose or make money. So let’s discuss the two scenarios;
Stock Goes Up In Price and Buyer Executes Option
If the stock goes up to $115 in a week and the buyer executes their option, I will collect $1000 from them but I’d also owe them shares at $110. And, since I own the 10 shares in question, I can simply sell them to the buyer. But, remember when I initially sold the contract, it was at $100, so selling it at $110 is still profitable for me.
Stock Remains at $100 and the Contract Expires
This is where things get interesting. So if the price of the stock doesn’t move in a week, the contract will expire worthless. But there is more to it. I get to keep my shares and pocket the premium for the contract, too. This is how investors make money with options trading.
this seems like a great source of passive income. I wouldn't hesitate to sell covered calls on the side for some extra cash as there is likely little risk!