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.

@shortsegments

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