Street Sense: The fundamentals of stock market investing
Sell "Call" Options for Income
This conservative strategy can provide you with additional current income from stocks that you already own.

BY JERRY HELZNER

 With dividend yields on common stocks at historically low levels, many investors would like to generate more current income from their stock portfolios. This month, I'll explain why selling "call" options on stocks that you already own is a conservative, safe way to add to your current income without incurring additional risk.

But first, I'd like to give you a very brief course on call options and how they work in the real world.

A call option is basically a claim of ownership on 100 shares of a specific stock at a specific price for a finite period of time. For example, if XYZ Corp. is trading at $18 a share today, you can buy or sell a call option giving the owner of the call the right to purchase 100 shares of XYZ for $20 a share until the third Friday in April. Because the call option represents a legitimate claim on 100 shares of XYZ until April, it has value that will rise or fall with the value of XYZ stock. If XYZ happens to jump to $25 between now and April, the call option will show a sharp increase in value. If XYZ falls to $15 and stays there during that time period, the value of the option will drop sharply and it will eventually be worthless.

CALL OPTIONS HAVE APPEAL

Call options aren't stocks, but they're traded like stocks. The options have appeal because they offer buyers opportunities for large profits with a relatively small outlay of money. Like a stock, each exchange-listed call option has its own symbol, enabling investors to obtain timely quotes on any option that they're seeking to buy or sell.

Speculators buy call options in the hopes of leveraging a small investment into a large profit. But why do people sell call options -- the strategy I'm advocating here? Let's look at XYZ Corp. again, this time from the perspective of the person who's selling the options.

With XYZ at $18, there are XYZ owners who would be happy to receive $20 a share for their stock. These investors should consider selling call options on XYZ because if the call buyer claims their stock in April, they'll receive exactly $20 a share. And the additional money they'll take in for the options they sell can be considerable.

SELL CALLS AND GET THE BENEFITS

Say you own 500 shares of XYZ, currently trading at $18 a share, but which you're willing to part with for $20 a share. Because you own 500 shares, you can sell five option contracts. You look up the symbol for the XYZ April 20 call option and see that a bidder is willing to pay $140 for each 100-share contract. If you sell the five call option contracts, you'll receive $700 (minus a small brokerage commission), which is yours to keep and which can immediately begin earning interest for you.

But that's not all. Let's say XYZ also pays a quarterly cash dividend of 20 cents a share. You'll continue to receive that dividend as long as you own those 500 shares of XYZ. So even though someone owns a claim on your XYZ shares, you get the $100 dividend.

By selling call options on your XYZ shares, you benefit in four different ways:

• you receive almost $700 for selling the five call options
• you can immediately begin earning interest on the money you receive from the five options that you sold
• you receive any dividends paid by XYZ as long you own the stock
• if XYZ is $20 or above by the third Friday in April, you'll sell the stock for a price that's $2 higher than it is now. If XYZ is below $20 on that day, you keep the stock and can sell more options.

THE RETURNS CAN BE SIGNIFICANT

By selling call options astutely, you can add 10 to 20% to the annual return from stocks that are already in your portfolio. The strategy is fairly simple, but if you're considering selling calls for the first time, work with a stock broker who's familiar with the concept.

Ophthalmology Management Associate Editor Jerry Helzner has written more than 50 articles on stock investing for Barron's. He has been a regular stock market columnist for other business publications and was a member of the equity research department of a major regional brokerage firm.