As I discussed in the first part of my options series, investors typically perceive options to be very risky and highly speculative. While this certainly true in many circumstances, that's not to say that it's impossible to use options of options to leverage an investment strategy.

While I focused on puts in my last options article, in this post I will focus on covered calls. Covered calls are the sale of call option contracts when you own the underlying stock, and therefore you are "covered." Unlike puts, where the option is exercised if the stock hits a predetermined price lower than the current price, calls are exercised if the stock hits a predetermined price higher than the current price.

Although covered calls have several different potential applications, in this post I'm going to focus primarily on one specific application -- generating income on a stock you would like to hold.

For many investors, constant buying and selling of stocks is unrealistic and undesirable. In fact, there is tremendous evidence to suggest that the more active an investor is the worse his returns are. As a result, many investors don't know what to do when a company they desire to hold reaches a price that they consider to be overvalued. Part of the investor believes over the long term the company's intrinsic value will continue to increase and he will regret selling now. But part of him wants to monetize the recent rally in the stock's price. In this situation, selling covered calls makes great sense.