For investors interested in using options, it's important to understand the underlying stock as well as the strategy in question.
In this segment from Motley Fool Live that first aired July 9, Motley Fool Canada analyst Jim Gillies, Motley Fool Options advisor Jim Mueller, CFA, and Fool.com editor/analyst Ellen Bowman discuss the way covered calls bring income.
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Jim Mueller: A covered call is a strategy to generate income from selling those calls over and over and over again and being paid that premium. You can get a bit of capital appreciation if you can roll the call that is by the current one and selling new one at a higher strike expiring further in the future. That gives you a bit of capital appreciation. But the main point of the covered call is that income every three months or so from selling that promise to sell the shares at the strike price.
Ellen Bowman: I think there's two things that why now and why covered calls on Starbucks? One being that we recommend covered calls for people who are in retirement in particular, in a service that's one of the things because they provide such recurring income.
Jim Mueller: That's how I'm going to pay for my retirement is writing options.
Ellen Bowman: On Starbucks. Exactly.
Jim Mueller: Yeah.
Ellen Bowman: Just don't do it if it goes to 3,000. [laughs] The other point that you guys have been touching on is that one of the reasons we recommended those strategy for beginners and one of the reasons that it's the strategy I'm going to start with is a beginning of investing, is because as much as both of you have heard otherwise, you can't really lose. Jim Gillies mentioned in a previous conversation that there's probably a way to leverage covered calls in such a way that you could go completely bankrupt, but generally, they're very safe.
Jim Gillies: It's hard to do so accidentally.
Ellen Bowman: Exactly.
Jim Gillies: You have to literally go out and get a margin loan and then buy more shares than you can afford and have it fall apart.
Ellen Bowman: There's some margin strategies that it's easy to leverage yourself without realizing it. But covered calls aren't one of the ones where you made a list of shares in which case you got paid for them. You may get paid and get to keep your shares. Your biggest regret is going to be, oh, my God, the stock went to $3,000 and I missed it, not the stock went to zero and I lost all my money. [laughs]
Jim Mueller: I still have to buy it at 110.
Ellen Bowman: Exactly.
Ellen Simonson Bowman has no position in any of the stocks mentioned. Jim Gillies owns shares of Starbucks. Jim Mueller, CFA has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Starbucks. The Motley Fool recommends the following options: short July 2021 $120 calls on Starbucks. The Motley Fool has a disclosure policy.