Covered Call Strategy

[Larry1234 10]

Hi All,

 

I am going to talk about what is covered call strategy and when to use the same.

 

Covered Call is a strategy in which an investor sells a call option on a stock he owns. In this strategy, the investor generally sells an Out of the money call option (Strike price > Current market price). The call would not get exercised unless the stock price increases above the strike price. Till then the investor in the stock (call seller) can retain the premium with him. This becomes his income from the stock. This strategy is usually adopted by a stock owner who is Neutral to Moderately Bullish about the stock.

 

Writing out-of-the-money covered calls is an excellent strategy to use if you are mildly bullish toward the underlying stock as it allows you to earn a premium which also acts as a cushion should the stock price go down. So if you are planning to hold on to the shares anyway and have a target selling price in mind that is not too far off, you should write a covered call.

 

Happy Learning

[Larry1234 10]

This thread is for those who like to discuss about the covered call strategy. I am waiting for more thoughts .

 

Happy Leaning

 

  Larry1234 said:

Hi All,

 

I am going to talk about what is covered call strategy and when to use the same.

 

Covered Call is a strategy in which an investor sells a call option on a stock he owns. In this strategy, the investor generally sells an Out of the money call option (Strike price > Current market price). The call would not get exercised unless the stock price increases above the strike price. Till then the investor in the stock (call seller) can retain the premium with him. This becomes his income from the stock. This strategy is usually adopted by a stock owner who is Neutral to Moderately Bullish about the stock.

 

Writing out-of-the-money covered calls is an excellent strategy to use if you are mildly bullish toward the underlying stock as it allows you to earn a premium which also acts as a cushion should the stock price go down. So if you are planning to hold on to the shares anyway and have a target selling price in mind that is not too far off, you should write a covered call.

 

Happy Learning

[ntrader 10]

Covered call strategies can be useful for generating profits in flat markets. Covered calls can also be used to achieve income on the stock above and beyond any dividends. The goal in that case is for the options to expire worthless.

I have a post on why I prefer the bull call spread instead of covered call which mabe you find it usefull http://www.traderslaboratory.com/forums/options-trading-laboratory/15367-why-i-prefer-bull-call-spread.html

[agewen 10]

  Larry1234 said:

Hi All,

 

I am going to talk about what is covered call strategy and when to use the same.

 

Covered Call is a strategy in which an investor sells a call option on a stock he owns. In this strategy, the investor generally sells an Out of the money call option (Strike price > Current market price). The call would not get exercised unless the stock price increases above the strike price. Till then the investor in the stock (call seller) can retain the premium with him. This becomes his income from the stock. This strategy is usually adopted by a stock owner who is Neutral to Moderately Bullish about the stock.

 

Writing out-of-the-money covered calls is an excellent strategy to use if you are mildly bullish toward the underlying stock as it allows you to earn a premium which also acts as a cushion should the stock price go down. So if you are planning to hold on to the shares anyway and have a target selling price in mind that is not too far off, you should write a covered call.

 

Happy Learning

 

Understanding all the nuances of this great strategy will allow the investor to use it in most market conditions and for all types of risk tolerances. risk and results can be controlled through strike price selection, evaluating the beta statistics of the underlying stocks and the implied volatility of the options. This may seem overwhelming at first but can easily be mastered in a short period of time. Selecting the appropriate stocks and options along with proper post-trade management can make this a lucrative and consistent cash flow strategy. It can also be used in self-directed IRA accounts.

 

Nice going promoting this strategy!

 

Alan

[Larry1234 10]

Apart from this, selling a naked put is the same as selling a covered call. They have identical profit and loss graphs if you use the same strikes and expiration dates. However, there are a few differences that may make naked puts more or less attractive than covered calls.

 

  ntrader said:

Covered call strategies can be useful for generating profits in flat markets. Covered calls can also be used to achieve income on the stock above and beyond any dividends. The goal in that case is for the options to expire worthless.

I have a post on why I prefer the bull call spread instead of covered call which mabe you find it usefull http://www.traderslaboratory.com/forums/options-trading-laboratory/15367-why-i-prefer-bull-call-spread.html

[agewen 10]

Agreed, very similar risk-reward profiles but not precisely the same. I view covered call writing as a more bullish strategy especially when writing out-of-the money calls. In addition, naked put writing is much more risky unless cash-secured. Finally, cc writing can be used in self-directed IRA accounts where naked put selling cannot. In bearish market environments I may sell a c-s put and, if exercised, write a call on the newly acquired shares thereby using a combination of the 2 strategies.

 

Alan (The Blue Collar Investor)

[Larry1234 10]

Agreed but in my opinion, the initial cash outflow in writing a covered call is much higher compared to selling a naked put. As we are holding the stock in covered call strategy, so we are moderately bullish about the stock and also getting the advantage of corporate actions (dividend, if any) and in case of selling a naked put, we need to see what is the strike price then we can make a comment regarding the market movement....

[agewen 10]

Larry,

 

I advise the use of naked option trading only to the sophisticated, experienced traders with higher risk tolerance. For some, this IS an appropriate strategy as long as the risks are understood and management techniques are mastered. For most retail investors, brokerages will require cash-secured, rather than naked puts to be used.

 

I agree that covered call writing is a more bullish strategy than put selling but it still can be used in bearish environments by utilizing in-the-money strikes, low-beta equities and even exchange-traded funds.

 

Alan

[Larry1234 10]

Adding one more point, one can also use covered call strategy for a particular stock if -

Dividend is expected on the stock in the near month, as dividend will give a cash flow to the trader and it will also decrease the share price so writing the call is also beneficial...

[agewen 10]

Larry,

 

Great point. I would also advise investors to carefully watch the time value of the premium in these cases. If TV < dividend distribution, there is a chance of early exercise the day prior to the ex-dividend date.

 

Alan

[Larry1234 10]

Hi Alan,

 

Thanks a lot. Can you please explain what is TV of premium? I am not sure about it

[agewen 10]

Larry,

 

Sure.

 

Option premium = Intrinsic value (amount the strike is in-the-money) + time value (amount over IV). Only TV is our profit. ATM and OTM strikes are ALL TV.Here's an example:

 

BUY XYZ $32

 

Sell $30 (in-the-money or ITM) call @ $3

 

IV = $2 (not profit, but protection of profit)

 

TV = $1 (our initial profit)

 

Here is a link to an article I published with more detail:

 

Covered Call Writing Premiums: Intrinsic Value + Time Value | The Blue Collar Investor

 

Alan

[Larry1234 10]

Alan,

 

Thanks a lot for the info.

 

Larry

[ThetaTrend 10]

It seems like covered calls are most advantageous to trade in two situations: one is when price is fairly depressed and volatility is high and the second is when the underlying is in a moderate uptrend. In both cases you should want to own the underlying.

 

In the first case, the premium you receive should be fairly rich and increase the yield of your underlying position up to your maximum profit. Note that the equivalent short put position or vertical spread might require less capital and result in a higher yield.

 

The second case where price is in a moderate uptrend and doesn't reach your short strike before expiration, but doesn't collapse or it does collapse and you have a predetermined exit point.

 

All that being said, I'm with ntrader and prefer to trade vertical spreads.

[agewen 10]

I respect your opinion. There is no one strategy that is right for every trader/investor. For me cc writing has worked the best in most market conditions. I control and max my results by selecting different strike prices, implied volatilities and betas depending on market conditions and chart technicals. This allows me to be successful in most market conditions as well as trade in sheltered accounts.

 

Wishing you much success.

 

Alan

[ntrader 10]

Every trader should estimate the current market conditions and various fundametals and technical factors and then apply the trading strategy which believes it fits to the current market conditions.