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Practical Options Trading Strategies

Views 20KAug 9, 2023

Covered Call Strategy

You can use a covered call strategy when you expect a security or asset's price to rise slightly and steadily within a certain range.

Construction of the strategy

A covered call strategy involves two trades.

● Buy a stock

● Sell a call of the stock

The amount of shares bought is equivalent to the amount of call option asset.

Brief description

A covered call involves selling a call covered by an equivalent long stock position.

The short call's main purpose is to earn premium income, which could lower the holding cost of stock and offer downside protection.

The investors who use this strategy choose the price they want to sell the stock as the strike price of calls. Then, if the stock rises to the strike price, they can sell it at the price they had wanted.

Gain & Loss

● Breakeven

Breakeven = Stock Purchase Price – Premium Received

● Max gain

Max Gain = Strike Price – Stock Purchase Price + Premium Received

● Max loss

Max Loss = Stock Purchase Price – Premium Received

Example

Imagine that there is a stock called TUTU on the NASDAQ, and its current stock price is $50. You expect it to rise moderately, so you use a covered call:

● Buy 100 shares of TUTU stock at $50

● Sell a $5 call with a strike of $55

(The following calculations do not include transaction costs.)

Options trading entails significant risk and is not appropriate for all customers. It is important that investors read Characteristics and Risks of Standardized Options before engaging in any options trading strategies. Opening new options positions close to or on their expiration date comes with substantial risk of losses for reasons that include potential volatility of the underlying security and limited time to expiration. Options transactions are often complex and may involve the potential of losing the entire investment in a relatively short period of time. Certain complex options strategies carry additional risk, including the potential for losses that may exceed the original investment amount. Supporting documentation for any claims, if applicable, will be furnished upon request.

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