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Purpose Of Covered Call
1. To create a monthly residual income stream from your stock
2. To create extra profit when a stock goes up or stays stagnant
3. To reduce loss on a falling stock
Expectations Of Covered Call
Up or Stagnant
How To Use Covered Call?
Write (sell to open) 1 contract of nearest out of the money or at the money call option
for every 100 shares you own.
Buy 100 Shares + Sell 1 Out Of The Money (OTM) or At The Money (ATM) Call Option
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Profit Potential of Covered Call :
Maximum profit occurs when the stock expires at the strike price of the short call options.
Profit Calculation of Covered Call:
1. If stocks are not assigned (called off) at expiration:
Profit = (value gained in stock + initial price of short call options) / initial value of underlying stock
2. If stocks are assigned (called off) at expiration:
Profit = ((strike price of short call options - initial value of underlying stock) + initial price of short call options) / initial value of underlying stock
3. If stocks have dropped in value at expiration:
Profit = (initial price of short call options - (initial stock price - stock price at expiration)) / initial value of underlying stock
Risk / Reward of Covered Call:
Upside Maximum Profit: Limited
Maximum Loss: Unlimited
Break Even Point of Covered Call:
There are 2 ways to look at breakeven point for a covered call.
1. As the Covered Call profits mainly from the decay of the short out of the money call options, the main way to look at breakeven is
the number of days it takes for the decay of the short call options covers its bid/ask spread.
Stagnant Breakeven point = Bid ask spread / theta
2. The lower breakeven point to find out how much the underlying stock can fall before you start making real losses to your account value.
Lower Breakeven point = Initial Value of Short Call Options - Initial Value of underlying stock
Advantages Of Covered Call:
Able to profit even if your stock stays stagnant.
Able to offset losses if your stock drops in value.
Disadvantages Of Covered Call:
You must continue to hold your stocks if you want to keep the short call options.
You can lose your stocks if it rises beyond the strike price of the short call options through assignment at expiration.
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