A Covered Call is a widely popular options strategy that is used to make extra money over a position in form of options premiums.
Setup:
Using Stocks –
- If the lot size of the stock is x; then Buy x amount of shares of that stock.
- Sell 1 lot call options (So that the net quantity of call options sold is equal to the shares bought).
Using Futures –
- Buy 1 lot in futures long
- Sell 1 lot call options
The short call is usually At-The-Money (ATM) or Out-Of-The-Money (OTM)
Directional Assumption: Bullish
Ideal Implied Volatility Environment: High (The more premium we get for our call options, the better!)
Max Profit: Distance between stock price & short call + premium received from selling the call
How to Calculate Breakeven(s): Stock price – credit from the short call [It dynamics reduces as the credit dynamically increases over each contract’s end.]
Note:
- The position limits the profit potential of the position as we are selling a call option.
- It is called “Covered Call” because the option seller is covered as he/she can deliver the shares needed if the contract gets exercised.
- This reduces the cost basis of the shares over time as when the share consolidates the option premium piles up as a profit.
- This also reduces the risk by the amount of option premium and in this way, the breakeven of the trade gets shifted to even lower side on each time we renew the contract.
Example:
Here goes an example of Covered Call setup –