Call options are a fantastic way to generate cash flow and reduce basis on companies we already own. When we already own a company we call a call option a "Rule #1 Call Option." Let me briefly explain the call option definition.
What is a Call Option?
Essentially, a call option example is a coupon to get cheap milk. There's two sides to this coupon. There’s the grocery store, which is essentially selling the coupon at a very, very, cheap price and there's the buyer of the coupon who is getting a right to go buy this milk.
So, when we use the coupon between the store, the store has an obligation to sell the milk at a set price and the buyer of the coupon gets the right to buy that milk at a set price. That’s just a coupon and we’re used to using them all day long.
Call Option Definition
Call options are just like that. Basically, if you sell a call option to someone, you are now obligated to sell them your stock at that price. If you buy a call option you now have a right to buy that stock at that set price for a set amount of time.
Selling Call Options
Why would we do that as Rule #1 Investors? If we own this company, and we sell someone the right to buy our stock at a price higher than we think it’s worth, then we have almost no risk whatsoever. Because, if the stock price goes up to that super high price, we want to sell it anyway. We want to sell into greed and we want to buy into fear.
If there is greed going on and the stock price is shooting up like a rocket, we want to be a seller of that stock. We can pick up cash flow, by putting out and selling call options, which basically gives someone the obligation to buy our stock at that higher price so that they buy it from us. They pay us a premium and we can put that money in our pocket.
If the stock price doesn't go up we get to keep our money. If the stock price does go up, then we sell the stock. Either way we win.
