Covered Calls


My first introduction into trading was by way of covered calls.

Covered calls are an income strategy and typically promise a 2% or so return per month. This strategy involves buying a share (or even a CFD) and selling a call against it. Variations of this strategy include buying an option ITM and selling an option OTM at a higher strike both with the same expiry.

Covered calls CAN work quite well in a market that is rising or going sideways but can present problems if a market is declining.

In addition to buying stock and selling a call, some educators will telly you to buy a put as ‘insurance’

Let’s take a look at an example using AAPL stock. See also other articles options and volatility

Here is a chart of AAPL today (8th May)

AAPL Chart

As you can see, this equity is in a strong uptrend which makes it a good candidate for a covered call. Last night, it closed at $153.01

Some of the factors to consider from a Technical Analysis standpoint could be:

  • close yesterday is higher than the close six months ago – confirms we are in an uptrend.
  • industry sector is also up. AAPL is in the Technology sector, XLK.XLK Sector
  • check the trend by plotting a 200 day simple moving average (SMA). Is stock trading above this line?
  • check the medium term trend is above 50 day SMA

Next it is a good idea to consider some fundamental factors with Fundamental analysis.

  • make sure the stock is not a motor vehicle, banking stock or a chinese stock – all these are either too volatile or too subject to government interference or regulation.
  • make sure the stock is not paying a dividend during the period of the option.
  • check the inside owners or institutional holdings in a company is >10%
  • stocks priced higher than $20 have a reasonable return
  • you can also check analysts grades and recommendations however I tend to place no weight on this at all.

To check out Technical Analysis, either use your own charting package, one of the freebies online or your broker platform will also provide charts and some of them allow you to draw moving averages and other indicators on your charts.

For fundamental analysis, try Finviz or try 4-traders

So we have decided we want to do a covered call on AAPL.

Here is the option chain.



AAPL May17 Option Chain

I would usually pick a strike price Out-of-the-money (OTM). Say we write the strike price at 155 expiring May17 which is in 11 days. We will receive $0.77 income per share for this.

I also need to consider a strike price for the ‘insurance’ put option. We may decide to protect 5% of our capital which means we would be looking for a Put strike around 95% x 153.01 = 145.36 so the best strike would be 145 or 146. Say we pick 146. This will cost us $0.22 per share.

So this will look something like this:

Purchase AAPL $-153.01
Sell Call 155       $     0.77
Buy Put 146       $-    0.22

Total Cost:         $-152.46

This is a return of 0.36% (153.01-152.46/153.01×100)

Not a good return. Ideally we would have written this covered call on the Monday after expiry in April. Remember this is just an illustration!

Let me put this into a trade ticket on Options eXpress. (the best platform for Options I have seen)Covered Call

In practice, I would watch this trade. Instead of buying a put, you could have a contingent order to close the position (Buy back the call and sell the stock) triggered it the stock was at a specific price which would save you the cost of the put. Also, if it gets close to expire and the stock price has fallen, you could close out the put (which will be worth much more money). Generally you should consider the position. If the put gets exercised, you will make a loss on the trade. You need to consider your opinion and what you think will happen to the stock in the next month.

Just remember: every huge loss started as a small loss! Be wise. Be prepared to take a small loss. I know educators will have you believe this strategy is a printing press however consider most traders make money maybe 30-40% of the time and everything else is a (hopefully) small loss or break even. There is no such thing as a 100% no-risk win rate over the long term! Be warned!

Originally posted 2017-05-09 11:02:54.