It works in a similar way that you rent out your house. You give control of your shares to another party for a certain period of time. And for this you receive a rental income called premium.

And just like the rental agent takes care of finding a tenant for you, the stock exchange takes care of finding someone to rent your shares.

Here’s how it works… Firstly you need to own some shares to rent out.  You can buy the shares and then rent them out, or you can buy the shares and rent them out in the one transaction. Let’s assume that we have bought some shares in company x for $38.00 per share and we bought 2000 of them, that’s $76,000. Now that we own the shares we can rent them out.

We do this by calling our Broker and saying that we want to “write a covered call”. What this means is that we will be selling the right for someone to buy our shares at a pre-agreed price by a pre-agreed date. The pre-agreed price is called the Strike Price and the pre-agreed date is called the Expiry Date.

So we might decide to rent out shares (or in technical words… write a covered call) with a Strike Price of $40.00 and an Expiry Date of the end of next month. And when we do this we receive a rental income called premium. Let’s assume the premium is $1.50 per share.

Now what does this agreement mean. It means that we have sold a promise agreeing to sell our shares for $40.00, if we are asked to, on or before the end of next month. And for this we receive $1.50 per share, in our example of 2000 shares that’s $3,000. And we receive this $3,000 immediately and we get to keep it no matter what.

Now if by the end of next month the stock price of our company x is at or below $40.00, do you think the other party would ask to buy our shares at $40.00. No they wouldn’t because they can buy them cheaper on the open market. Only if the stock price rises to above $40.00 would the other party ask us to sell our share for $40.00. And if they do, we are obliged to sell. That why we got paid the $1.50.

So the other party believes that the stock price is going to rise above $40.00 be the end of next month. If they are right they profit but if they are wrong they lose. We get to keep the premium paid regardless.

So we are effectively trading potential capital gain on our stock for guaranteed income i.e. the premium. To get the most from this strategy you need to select the right stock. You may not for example, want to do this strategy on “growth” stocks that are experiencing big gains because you’ll miss out on this gain.

However if you have stock that are going nowhere, why not rent them out and receive some free income from them.

You might like do some more reading and study of this. Just search the web for Covered Calls and you’ll find a stack of material.

This strategy is pre-programmed in Paper-Trader