Covered Calls For Beginners

What is a Covered Call?

covered call is a strategy by which you sell (write) a call option while owning shares of the underlying stock at the same time.

Why Sell a Covered Call?

The goal of selling (writing) a covered call is to increase your income while owning the stock. The income (premium) you receive from selling the call also covers a decline in the price of the stock.

Owning the stock and writing the call can outperform just owning the stock. The stock price can fall, stay the same, or rise enough to be profitable. Writing call options and owning stock will reduce volatility (the higher the volatility, the higher the risk).

Covered Call: Writing for Protection Example

Let's start with an example. Say an investor buys 100 shares of XYZ common stock at $48. The investor then sells 1 XYZ July 50 call option. This is called a covered call. The investor would receive $300 from the sale of the July 50 call.

Profit & Loss Terms

  • Max Profit: Distance between stock price & short call + premium received from selling the call.
  • Breakeven: Stock price - credit from short call.
  • Loss: If the stock price falls significantly below the $300 premium you received.

covered calls for beginners

Which Stock Should I Choose?

I recommend you choose low-priced stocks with a high implied volatility percentile. High IV means more premium is received for selling the call. You can trade high beta stocks which will generate a lot of premium, but the stocks also move around a lot, which can be stressful. I prefer low beta stocks and ETF’s like KO, JNJ, PFE, and IYR.

Which Call Do I Choose?

The short call is usually In-The-Money (ITM) or Out-Of-The-Money (OTM). The OTM call offers a higher potential for reward, but it is riskier than the ITM call.

When do we Exit Covered Calls?

One should exit covered calls when the stock price has gone past the short call; that will give close to maximum profit. You should close a covered call if the stock price drops significantly.

1 2
View single page >> |

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 ...

more
How did you like this article? Let us know so we can better customize your reading experience.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.