In today’s stock market, investors have more choices than the purchase of stocks, bonds or mutual funds. Strategies such as the buying and selling of options can increase returns or minimize losses.

Options are categorized into two different types, a call option and a put option. We are going to discuss call options. A call option is defined as a contract that gives the holder the right to buy the underlying security at a specified price for a certain, fixed period of time.

Generally, buying one option contract gives the purchaser the right to buy 100 shares of a stock. If the stock price exceeds the intended price (known as the strike price) the option can be exercised and profit made on the difference between the current price and the strike price.

As long as a market exists for the option, it can be bought or sold any time until it expires. Options become worthless at expiration if they are not sold or exercised prior to that date.

It is possible for an investor to be either a buyer or a seller for a call option. Selling naked calls means that an investor will sell an option without owning stock to offset the option. This is a high risk strategy and therefore most brokers will require substantial equity in your account before they approve you for this strategy. If you sell a naked call, General Electric, for example at a $15 strike price with two months left until expiration you would receive $100. That $100 represents the option premium. If the stock stays below $15 per share you get to keep the $100 premium which you made with no money invested because you sold a naked call. Sounds fantastic, right? However, if stock shoots up to $40 per share, you would be obligated to go to the market and purchase 100 shares of GE for $4,000 and deliver it to the option holder for a loss of $2,400 ($1,500 strike price received less $4,000 cost of shares plus $100 option premium received.) I hope you can see why this strategy carries unlimited risk. I do not recommend this strategy for new option traders.

A safer strategy is to sell covered calls, where the investor owns the underlying stock, and sells the call option. If you had owned the GE stock in the above example you would have simply delivered the 100 shares you already owned to the option holder, and received the strike price of $1,500, and kept the $100 premium.

I know what youre thinking. I just gave up all that increase in stock price by selling GE at $15 per share instead of $40 per share. This is true. You should never sell covered calls on stock that you want to keep. Before you sell covered calls you need to look at your investment in the stock and calculate your potential gain/loss if the stock were to get called away.

I successfully use covered calls as part of my investment strategy. Covered calls provide a safe, reliable method for me to generate consistent returns regardless of which direction the stock market moves. The key is learning a little known variation of this popular strategy to increase your success rate in all market conditions.

There are many investment training strategy websites and e-books that promise you incredible things. One of the more common stock market trading strategies taught is to sell covered call options on stocks. These websites maintain that you can earn monthly returns up to 10% or more using that very strategy! Sound good? Read on.

I will be the first to admit that selling out-of-the-money covered calls can bring lucrative monthly returns under the right circumstances. This strategy has been successfully used by me. However, this strategy is not without its disadvantages. The public has not been properly educated by the website and e-book marketers. They market this strategy as conservative with little risk. They leave you holding the bag when it all goes wrong.

When the stock market is rising in value selling out of the money covered calls works well. Additionally, when the stock market is neutral (not going up or down by any meaningful amount), this strategy also works well. Please tell me when the last time was that the stock market remained neutral for any length of time?

We are currently in the midst of an extremely volatile market. We have recently seen swings in the Dow as much as 200 points in either direction on any given day. Hardly a profitable market for an out-of-the-money covered call writer. Once that stock you are holding starts to decline, so do your profits. I can assure you that profits can evaporate very quickly. I have seen stocks fall from $10 per share to $1 per share over night! There is never enough premium on an option sale to cover that kind of decline.

The key to out-of-the-money covered call writing is to select stocks that will get called. Many so called experts do not want the stock to get called. They want you to keep the stock so you can sell a covered call option on it the next month. This strategy is flawed. You need to select stocks that are trending up in value, hence, a rising market. Those stocks will make you the most money. If the stock gets called, I know I ended up making my maximum anticipated return.

What if the stock shoots way up in value? If the stock shoots up through the strike price and remains there at expiration, it simply gets called away. Isn’t that what you wanted to begin with? You may think you left money on the table by not being able to participate in those gains. If that upsets you then just buy the stock outright and don’t sell covered call options on that stock. Instead, let the stock get called away and take your profit for the month. Then look for another stock to buy and sell calls on for the next month.

Remember, selling out-of-the-money covered calls can provide an excellent source if income in a rising stock market. However, this strategy is less than ideal in a stock market like the one we find ourselves in today. There are, however, other strategies that will offer significant protection in a volatile or declining stock market.