What Are Surety Income Certificates?
- Surety income certificates are just a type of option. Specifically they are selling a covered call. The term surety income certificate was created because many investors believe options are risky investments. Therefore, they immediately close their minds to the possibility of using them before hearing how they possibly can be used in a way that offers lower risk. Consider three components: What are options? What are calls? What does it mean when a call is covered?
- The standard definition of an option is the right, but not the obligation, to buy (or sell) the underlying asset at a specific price on or before a given date. The buyer of an option pays a premium to the seller in exchange for the right to buy the underlying stock at a future date at a certain price. For instance, if the stock is currently selling at $30 and the buyer expects it to go to $35, he might be able to buy a $32.50 call option from someone for $1.50. Even if the price goes above $32.50, he can still buy it for $32.50 because he paid the $1.50 premium. If it goes above $34 ($32.50 plus $1.50), he makes a profit. At $35, he would make a $1 profit on his $1.50 initial investment.
- The above option example was a call option. The buyer has the right to "call" the stock away from the seller at a given price if the stock price rose enough. In the case of a put option, the buyer has the right to sell or push or "put" the underlying stock to the seller of the option. In this case, the seller of the option has to buy the stock at a fixed price even if the price falls far below that price. The buyer of a put is buying insurance that he won't lose more than a certain amount even if the price falls to zero.
- In the case of "surety income certificates," the author is talking about being a seller of covered calls. "Covered" means you own the underlying stock. But because you are selling the calls, someone has the right to buy them from you at a higher price, just as in our $30 stock example. If you expect the price of the stock to remain flat or go down, you can sell the call option and keep the premium and the stock when the option expires, because the option buyer will only exercise his option if the stock price rises. This is a way to generate additional income from your stock portfolio.
- Covered calls are a relatively low risk form of options. Because you already own the stock, your risk is not unlimited as in some forms of options. In a case in which the call is exercised, you are forced to sell your shares at a price you thought was advantageous when you sold the option. In addition to the sales price, you also get to keep the option premium. If the price of the stock is flat or down, you get to keep the option premium, which helps cushion any loss of value of your stock, and you can sell another option the following month.
