Contents
- What Is A Covered Call?
- Why Is It Important To Write Good Covered Calls?
- What Happens Next?
- Final Thoughts
Today, we’re looking at how to write covered calls.
When you write a covered call, you sell the right to purchase a stock that you already own at a certain price and time.
Given that one option contract normally corresponds to 100 shares, you must possess at least 100 shares for each call contract you wish to sell in order to employ this strategy.
Upon selling (or “writing”) the call, you will receive the premium instantly.
Since you already own the shares, you are protected if the stock price rises over the strike price, and call options are provided.
You will just deliver the stock you now own, reaping the additional benefit of the stock’s appreciation.
What Is A Covered Call?
A covered call is a financial transaction in which the investor selling call options also owns the underlying securities.
An investor with a long position in an asset writes (sells) call options on that asset in order to generate revenue.
The cover is the investor’s long position in the underlying asset, which enables the seller to deliver the shares if the call option buyer executes.
When an investor with a long position in an asset writes (sells) call options on that asset, a covered call is executed.
Those who want to own the underlying stock for a lengthy period of time but do not foresee a substantial price increase in the near future commonly employ covered calls.
Why Is It Important To Write Good Covered Calls?
Choose a high-performing stock from your portfolio that you are willing to sell if the call option is exercised.
Avoid choosing a stock for which you have a very optimistic long-term view.
Therefore, you will not feel as guilty if you are forced to sell the stock and lose out on potential earnings.
Choose a strike price at which you would be willing to sell the shares.
Typically, the strike price you choose should be out-of-the-money.
Because the goal is for the stock’s price to rise further before you are required to sell.
Choose an option contract expiration date.
As a starting point, consider 30-45 days into the future, but use judgment.
You should seek a date that provides a suitable premium for selling the call option at the specified strike price.
Some investors think a premium of 2 percent of the stock’s value is reasonable as a general guideline.
Remember that time is money when alternatives are available.
The more into the future one looks, the more valuable a decision becomes.
However, the further into the future one looks, the more difficult it is to predict what may occur.
Alternatively, avoid accumulating an excessive quantity of temporal value.
If the premium appears exceptionally high, there is often a reason behind it.
Check for market news that might affect the price of the stock, and keep in mind that if something seems too good to be true, it generally is.
What Happens Next?
This work has three potential outcomes:
Stock Goes Down
If the stock price is lower when the option expires, the call option will expire worthlessly and you will keep the whole premium collected from selling it.
Obviously, the value of the stock has plummeted, which is negative news.
This is a characteristic of a covered call.
Stock ownership is related to risk.
However, the benefit from selling the call might somewhat offset the stock’s decline.
Do not worry if the stock falls before the call’s expiration date.
You are not restricted to your present role.
Although stock losses will mount, the value of the sold call option will also fall.
Then, it will be possible to buy the call back for less than you made selling it.
If your opinion of the stock has changed, you may liquidate your position by repurchasing the call option and then selling the underlying stock.
Stock Plateaus
Actually, there is no bad news in this situation.
Your sold call option will expire worthless, allowing you to keep the whole purchase price.
You may have realized profits on the underlying stock, which you will maintain ownership of.
You cannot complain about your situation.
Stock Goes Above Strike Price
At expiration, the call option will be granted and 100 shares of stock must be sold if the stock price is above the strike price.
If the price of the shares skyrockets after you sell them, you may be inclined to resent yourself for missing out on more profits.
However, avoid the desire.
You determined intentionally that you were willing to sell the stock at the strike price, and you realized the maximum profit potential of the approach.
Final Thoughts
Numerous individuals use covered calls as their first foray into the realm of options trading.
There are risks involved, but the greatest danger comes from holding the stock, not from selling the call.
Selling the option has no effect on the upside potential.
When executing a covered call, you profit from the time decay of the options you’ve sold.
Each day that the stock does not move, the value of the call you sold drops, which is beneficial to you.
Time decay is an essential concept.
Therefore, it is advantageous for you as a novice to observe it in operation.
Your shares will not be called away as long as the stock’s price is below the strike price.
This procedure may theoretically be done forever on the same stock.
And as you execute more covered calls, your knowledge of the options market will expand.
Additionally, you may look smarter to yourself in the mirror.
Nonetheless, we provide no guarantees in this regard.
We hope you enjoyed this article on how to write covered calls.
If you have any questions, send an email or leave a comment below.
Trade safe!
Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.
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