Covered call stock option trading strategy

What is a covered call?

The covered call option trading strategy is a bullish option position that may be implemented when you think there may be a rise in the price of the underlying security or even if you think that the stock may be temporarily range bound.

The Covered Call (Aka Buy write) option strategy is a very popular stock and option strategy that entails owning the underlying stock and simultaneously selling an out of the money Call option contract.

The buy write is a very popular option trading strategy and should only be implemented when fair consideration has been given to proper risk management.

One of the reasons someone might take advantage of the covered call option strategy is when a trader or investor is short term neutral to long term bullish regarding their sentiment of underlying stock. They implement the position in order to continue to enjoy the shareholder benefits that come with owning the stock outright (voting rights, dividends, etc.).

An important consideration when initiating a covered call option position is the fact that time decay has a positive impact on the short call options premium. Every day that passes by further erodes the time (measured through theta) portion of the short call options price which contributes to a profitable short position.

Also keep in mind that any rise in implied volatility (IV) may have a negative impact on a the short call option position. (Implied Volatility is measured through Vega).

The chart above is an illustration of the following example.--

~Buy 100 shares of stock at $30.00 per share.

~Sell 1 out of the money 40 strike call option contract @ $5.00 bid.

~Total cost of stock purchase excluding commission= $3000 ($30.00x100).

~Strike price of the short call= $40.00

~Break even point at expiration= Purchase price of stock ($30.00)- credit received from selling the call= ($5.00)= $25.00

Maximum profit= $1,500 (Short strike-purchase price+net credit received from short call.)

Maximum loss= $2,500

This example illustrates a trader or investor holding the covered call option position through the contracts expiration cycle. Remember, at expiration, all that is left in an call options premium is the intrinsic value of the said option contract.

Notice how your break-even point on the trade is reduced by the net credit received, from the premium received by selling the short call option contract. Also notice how your upside potential is capped.

Remember a major advantage of the covered call option position is that one can collect additional premium while simultaneously reducing their cost basis on the existing underlying stock position.

The Covered call allows much opportunity. Through Proper risk management, knowing the reasons why you entered the trade, as well as your exit strategy, combined with the ability to make the necessary adjustments, one will be well on their way

to trading covered calls profitably.

Custom Search