Writing covered calls is considered to be a very conservative option strategy. For that reason, more aggressive investors may ignore the strategy because of the limited upside. However, you can also use it as part of an aggressive strategy.

Quick Review of a Covered Call

For our readers who may be beginners to options trading, a covered call is when you write (i.e., short) a call option against a stock you already own. You must own at least 100 shares of a stock to write a call against that stocks. Each option contract is equivalent to 100 shares.

For instance, if you have 250 shares of General Electric (NYSE: GE), the most of number of calls you can write for a completely covered call is two. If you write three calls, that third call will only be partially covered by the remaining 50 shares. If all three call options are exercised by the counterparty, you would need to buy 50 shares of GE on the market to cover the position.

Since the call options won’t be exercised unless the market price of GE is higher than the strike price, you will be incurring a loss on each share of GE you have to buy to fulfill your end of the bargain. Let’s say the strike price is $15 and GE is trading at $18. Besides having to sell your 250 shares of GE to the call option holder at $15, you have to buy another 50 at $18 and sell them at $15. Your loss on those 50 shares is $150 (50 shares x $3).

The higher GE’s market price, the more you stand to lose. Thus, if you want to do a covered call, it’s a good idea to 1) not write more contracts than you have shares to cover, and 2) pick a strike price at which you would not mind selling your shares.

How a Covered Call Can Help

Now let’s return to how you can use covered calls to help you as part of an aggressive strategy.

When you sell covered calls, you collect premiums. That cash is yours to keep and you can do whatever you want with it.

Let’s go back to the GE example.

With 250 shares of GE, you decide to sell two September 15 calls. As of the afternoon of February 5, you can get about $116 for the two contracts ($0.58 x 200). Let’s face it, $116 isn’t even enough to buy one share of many stocks nowadays. However, you can certainly buy options with the money and try to go after bigger percentage gains.

At this very moment as I write this article, GE is trading at around $11.35. This means that for you to lose 200 share of your GE holdings, the stock would need to rally by at least 32% by the expiration date (September 17). If that doesn’t happen, then the calls will simply expire worthless. You would still have 250 shares of GE that you sell more GE calls again if you want to.

Even if GE did move past $15, the gain from $11.35 (current price) to $15 belongs to you. Plus, you also pocketed the $0.58 per share in option premium.

Ask yourself if you are willing to sell GE at $15. If you answer yes, then the covered call is a pretty good deal.

How Aggressive Do You Want to Be?

If you really want to swing for the fences with the $116, one way would be to buy way out-of-the-money (OTM) call options for stocks that you think will have some significant event happening soon. Options that are far OTM have little chance of making it into the money, so they are low price.

Most such OTM calls will expire worthless, but if you happen to catch one just right (e.g., if the company blows away earnings expectations and issues tremendous forward guidance) and the stock jumps, you could have major gains on your hands. If a $0.20 call becomes just $2, you have a tenfold gain.

If you prefer to take a more conservative route, you can buy options that are less out of the money. They are more likely to finish in the money. The drawback to this is that the option will cost more. What the “right” move for you is depends on your risk tolerance and your goals. In any case, you can keep using covered calls to raise extra cash for you to make aggressive bets over and over again.

That’s the beauty of options. They offer tremendous flexibility and allow you to tailor your trades to what you want to do.

Editor’s Note: Our colleague Scott Chan just described a time-proven options trading strategy, but maybe options aren’t your cup of tea. Not everyone is comfortable with options.

That’s why our investment team has put together a special report: “5 Red Hot Stocks to Own in 2021.” In this report, we provide the names and ticker symbols of the highest-quality stocks to own for the new year. These stocks are appropriate for any type of investor. Click here for your copy.