Covered Calls

Published on: Dec 07 2017 by John Critchley

 

Covered Calls

 

What is a Covered Call?

 

The covered call strategy involves owning or buying stock and selling an appropriate number of calls against it. The covered call strategy involves buying (or owning) 100 shares of a stock and then selling a call that is “covered” by the stock (since 1 options contract usually controls 100 shares of stock). The sale is a credit and adds cash to your account. However, while selling the call brings income to the account, it creates the obligation to sell the stock if the call is assigned. Covered calls are profitable within a defined range. They profit if the stock price drops by less than the amount of the sold call, and remain profitable if the stock moves up to or beyond the strike price of the call sold. The maximum gain is realized if the stock price is at the strike price. At that point, the full value of the sold call is retained while the stock has achieved its maximum without assignment.

 

Example: With the stock at 48, you sell a 50 call for $1. If the stock goes to $49.50, you gain $1.50 per share and keep the $1 of premium.

 

 

If the stock goes to 47.20, there is .20 of profit. Your stock would have lost $.80, but you gained $1 from selling the call option. Meanwhile, if the stock goes to 50.30 at expiration, the call will be assigned and the stock sold. You will recognize a $2.00 gain in the stock price and $1 profit from the option premium which you received; but of course you will have sold your stock.

 

Be aware that if the stock takes off and moves beyond the strike price sold, the position will not partake in those gains. You still make a profit, but there is the possibility of assignment before expiration. If the stock price is above the strike price at expiration, you will be assigned.

To reiterate, the covered call will profit from the stock’s moving up, staying flat, or falling no more than the credit from the sold call.

 

When should I consider implementing?

 

  1. Generate income in neutral or rising markets
  2. It can generate extra income in your account and potentially reduce volatility.
  3. You want to get paid to sell your long stock position.
  4. You own a stock that is part of your long-term investment portfolio. You like it long term, but don’t see it going anywhere over the short term and would consider selling it, given the right terms. You would also like to generate some income.
  5. Many traders use covered calls to generate income in their accounts. It’s highly conservative nature makes it very popular. This is a level 1 or beginner option strategy.

Disclaimer


We are not liable for any trading decisions made by any reader. NO advice is given or implied. The information offered in this article is for demonstration purposes ONLY and should not to be either construed as an offer or considered to be a recommendation to buy or sell any options.

Your use of this information is entirely at your own risk. It is your sole responsibility to evaluate the accuracy, completeness and usefulness of the information. You must assess the risk of any trade with a professional broker, or financial planner, and make your own independent decisions regarding any trades mentioned herein. This is not a solicitation to buy or sell any options, or to purchase or sell any credit spreads. Trading options only carries a high degree of risk, is not suitable for all traders/investors, and you may lose all of your premium money invested in the options. If you have never traded options before, we strongly recommend that you read a little background information made available by the government. Only you can determine what level of risk is appropriate for you. Also, prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options.

Past performances DO NOT guarantee future results. Please consult with your own independent tax, business and financial advisors with respect to any trade. We will NOT be responsible for the consequences of anyone acting on this purely demonstration material

 

 

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