Options Trading: The Covered Call
Options Trading: the Covered Call.
One of the first options trades I learned was the popular Covered Call.
Definition: It is considered a “Safe strategy” with capitol preservation and potentially monthly gains. It is called COVERED CALL because you sell some one the Option to buy a stock, called CALL OPTIONS, at a certain time and a certain price, while COVERING that obligation with actual shares you own.
How to set-up the trade. You set it up by buying 100 shares of a stock like Tesla at 180$ per share, then sell someone the option to buy it for 200$ in four weeks. They pay you a premium which varies but could be 4$ per share or 400$. So you pay 180$ per share for 100 shares, or 18,000$. Then you sell one contract of 200$ calls expiring in 4 weeks for 4$ per share premium or 400$.
*Next If the price of Tesla goes above 200$ in 4 weeks, your options get exercised and you get paid 200$ per share and keep the 400$ premium paid initially. So you profit 4$ and $20 per share. If Tesla doesn’t reach 200$ in 4 weeks you keep the premium from the call options you sold and the option expires. You now can sell another call option if you wish for another strike price with a 4 week expiration.
Review It probably sounds wonderful and to good to be true. Well it’s true but not always so profitable. Sometimes the premiums aren’t 4$ but much less like 1$, But the strike prices are the same. It’s still a good way of earning money on a stock your holding for future appreciation and effectively reduces your basis, plus oddly enough, it’s a win-win.
Win-Win You win because you have enough capitol to buy and hold Tesla, and because you sell a call option guaranteeing a small monthly profit or if your options get exercised you get to sell at a good price for a good profit. The buyer of your call options wins because they get to invest in Tesla and benefit from its appreciation over the next 4 weeks with out investing 18,000$, but instead 400$. So while it may seem like a bad deal for the buyer you have to look at the math, mainly the ROI or return on your investment.
Review the Math You: Spend $18,000 on 100 shares of Tesla. You sell one contract of 200$ calls on Tesla expiring in 4 weeks. Your ROI is 400/18,000= around 2%, not great but annualized it’s 26%
Buyer Invests $400 in one contract call options with 200 dollar strike price. If Tesla price rises to 201$ they exercise their right to buy at 200 and sell for 201. They make 100$ on 400$ invested or a ROI of 100/400 or 25% and 300% annualized.
*Win-Win part Now your ROI as seller of the call options is lower at 2%, but safer and if you get called out it could be 20%. You don’t really expect a 10% one month jump in price that 180$ to 200$ would require, that’s why you sell the options. The buyer doesn’t have the 18,000$ in capitol to buy one hundred shares, but the option for $400 allows the buyer to earn money as if they own 100 shares because the option gives them temporary control over them through their purchased option to buy at 200$.
I realize that’s a fair amount of math, but you’ll learn to love options math because it always adds up to dollars and if you learn enough you will be able to free yourself.
Posted Using LeoFinance
