What Is Covered Call Options Trading Strategy?

Nilesh Jain

21 Feb 2017

A covered call options trading strategy is an Income generating strategy which can be initiated by simultaneously purchasing a stock and selling a call option. It can also be used by someone who is holding a stock and wants to earn income from that investment. Generally, the call option which is sold will be out-the-money and it will not get exercised unless the stock price increases above the strike price.

How should you use the covered call Options Trading strategy?

Choosing between strikes involves a trade-off between priorities. An investor can select higher out-the-money strike price and preserve some more upside potential. However, more out-the-money would generate less premium income, which means that there would be a smaller downside protection in case ofstock decline. The expiration month reflects the time horizon of his market view.

Strategy Buy Stock & Sell call option
Market Outlook Neutral to moderately bullish
Breakeven(Rs.) at expiry Stock price paid-premium received
Maximum Risk Stock price paid-call premium
Reward Limited
Margin required Yes

Let’s try to understand the Covered Call Options Trading Strategy with an Example:

Current ABC Ltd Price Rs. 8500
Strike price Rs. 8700
Premium Received (per share) Rs. 50
BEP (strike Price - Premium paid) Rs. 8450
Lot size (in units) 100

Let us consider the following scenario: Mr. X has purchased 100 shares of ABC Ltd. for Rs.8500 and simultaneously sells a call option with a strike price of Rs. 8700 for Rs.50 which means that Mr. X does not think that price of ABC Ltd will rise above Rs. 8700 till expiry. Thus, the net outflow to Mr. X is (Rs.8500-Rs.50) Rs. 8450.

The upside profit potential is limited to the premium received from the call option sold plus the difference between the stock purchase price and its strike price.

In the above example, if stock price surges above the 8700 level, then the maximum profit would be calculated as:(8700-8500 +50)*100 = (250*100) = Rs. 25,000. If the stock price stays at or below Rs. 8700, the call option will not get exercised and Mr. X can retain the premium of Rs. 50, which is an extra income.

For the ease of understanding, concepts such as commission, dividend, margin, tax and other transaction charges have not been included in the above example.

Any increase in volatility will have a neutral to negative impact as the option premium will increase, while a decrease in volatility will have a positive effect. Time decay will have a positive effect.

Analysis of Covered Call trading Strategy:

The covered call strategy is best used when an investor wishes to generate income in addition to any dividends from shares of stocks he or she owns. However, it may not be a very profitable strategy for an investor whose main interest is to gain substantial profit and who wants to protect downside risk.

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Why to Choose Mutual Funds Instead of Directly Investing Into Equities?

Whether to invest in equities or mutual funds is a question that has plagued every investor. As someone who needs the best value for his/her investment should you invest in equity directly or via mutual funds?

Let’s start by first understanding what these two terms ‘equities’ and ‘mutual funds’ stand for-

Equities- Equities generally represent ownership of a company. If you own any equity in a company, you are a part owner of the said company (depending on how much equity you own).

Mutual Funds – It is an investment scheme which is professionally managed by an asset management company. It pools together the resources of a group of people and invests their money in equities, debentures, bonds and other securities.

Why choose mutual funds over equities?

For people who’ve never invested in either stocks or mutual funds, it is hard to know which is better and where to start. Broadly speaking, if you are a novice investor, mutual funds are not only less risky but also way easier to manage. Here are some ways in which investing in mutual funds is beneficial as opposed to investing in equities -

Diversification

Mutual funds provide more diversification as compared to an individual equity stock. When you invest in equity, you are investing in a single company which has its inherent risk. For example, if you invest Rs.20,000 in buying equities of one company, you could face a total loss if that particular company performs poorly in the market.  

If you invest the same amount in mutual funds, it will be invested in different kinds of stocks and financial instruments, high-risk and low-risk both, so you might not face total loss even if one company does poorly.

Scale of Investment and Lower Costs

For an individual investor buying and selling stocks is a difficult task due to its high price. Thus, any gains made from stock appreciation are nullified if the overall trading costs are considered. Comparatively with mutual funds, as the money is pooled from a large number of investors, the cost per individual is lowered.  

Another advantage of mutual funds is that you don’t need to invest large sums of money. Buying equities for a profitable venture needs huge amounts of money, a minimum of few lakhs. With mutual funds, you can start with Rs.1000 and earn profits on that as well.

Convenience

Keeping an eye on the markets everyday is a time-consuming business, especially if you are investing as a side gig. There are people who spend their lives studying the market and still end up sustaining heavy losses. Though investing in mutual funds does not guarantee high returns, it is stress-free and needs less work as compared to investing in equities.

To sum it up

It is important to remember that mutual funds have their own disadvantages as well. Thus, as with any financial decision, educating yourself and understanding the suitability of all the available options is the ideal way to invest. 


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What Is Covered Call Options Trading Strategy?

Nilesh Jain

21 Feb 2017

A covered call options trading strategy is an Income generating strategy which can be initiated by simultaneously purchasing a stock and selling a call option. It can also be used by someone who is holding a stock and wants to earn income from that investment. Generally, the call option which is sold will be out-the-money and it will not get exercised unless the stock price increases above the strike price.

How should you use the covered call Options Trading strategy?

Choosing between strikes involves a trade-off between priorities. An investor can select higher out-the-money strike price and preserve some more upside potential. However, more out-the-money would generate less premium income, which means that there would be a smaller downside protection in case ofstock decline. The expiration month reflects the time horizon of his market view.

Strategy Buy Stock & Sell call option
Market Outlook Neutral to moderately bullish
Breakeven(Rs.) at expiry Stock price paid-premium received
Maximum Risk Stock price paid-call premium
Reward Limited
Margin required Yes

Let’s try to understand the Covered Call Options Trading Strategy with an Example:

Current ABC Ltd Price Rs. 8500
Strike price Rs. 8700
Premium Received (per share) Rs. 50
BEP (strike Price - Premium paid) Rs. 8450
Lot size (in units) 100

Let us consider the following scenario: Mr. X has purchased 100 shares of ABC Ltd. for Rs.8500 and simultaneously sells a call option with a strike price of Rs. 8700 for Rs.50 which means that Mr. X does not think that price of ABC Ltd will rise above Rs. 8700 till expiry. Thus, the net outflow to Mr. X is (Rs.8500-Rs.50) Rs. 8450.

The upside profit potential is limited to the premium received from the call option sold plus the difference between the stock purchase price and its strike price.

In the above example, if stock price surges above the 8700 level, then the maximum profit would be calculated as:(8700-8500 +50)*100 = (250*100) = Rs. 25,000. If the stock price stays at or below Rs. 8700, the call option will not get exercised and Mr. X can retain the premium of Rs. 50, which is an extra income.

For the ease of understanding, concepts such as commission, dividend, margin, tax and other transaction charges have not been included in the above example.

Any increase in volatility will have a neutral to negative impact as the option premium will increase, while a decrease in volatility will have a positive effect. Time decay will have a positive effect.

Analysis of Covered Call trading Strategy:

The covered call strategy is best used when an investor wishes to generate income in addition to any dividends from shares of stocks he or she owns. However, it may not be a very profitable strategy for an investor whose main interest is to gain substantial profit and who wants to protect downside risk.

Have Referral Code?