Stock traders are always searching for different strategies to generate maximum returns from the market. There are various strategies available & Of course, each strategy produces relatively lesser or more returns compared to the other. Depending upon Risk: Reward ratio.
Covered calls are one such strategy. One of the key factors here is the difference Between In the Money & Out of the Money options. Traders can book good profits through covered calls during decent upwards market movements. First of let’s understand,
Table of Contents
What are the Covered Calls?
Covered calls are about making additional income from the various stocks that you already own. The concept is to Sell call options and make income from the Premium that you collect while selling the Call option.
As a trader, You are writing Call options for the Stock(s) that you already own. Whenever someone Buys your call option – they pay the premium amount and that makes up your Income from this strategy through options strategy builder.
In this strategy, Traders would always be Selling “Out of the Money calls”. This way you are selling a Call option where the strike price is above the current market price. So in case of the option gets exercised by the Call buyer, you would still make some amount of profit.
How do you make Money with Covered Calls Strategy?
There are 2 main Contributors to the Profit from this strategy:
1) Options premium amount collection:
Under this strategy, the trader is selling Out of money call options. So when someone feels interested in your particular stock/option – They will have to pay a premium amount to you in order to Buy those Options.
There is a very high chance that the Option remains unexercised because you have already kept the strike price enough above the Market price. So the Option contract would expire after a few days, and you get to keep the premium amount. The sure shot profit.
Using a good quality options trading app is also important for smooth sailing here.
2) Profit when Option gets exercised:
In the above step, we considered the option expiring and you keeping the premium amount. But it is genuinely possible that the Market price hits the strike price that you have set and the Option ends up Exercised.
For example, You bought Reliance Retail’s stocks at ₹1000 per unit. The current market price is ₹1,200 & you have kept the Strike price at ₹1,400. So even if the market price increases and the Option gets Exercised – You would still make a profit of ₹200 per unit from the contract price.
SpeedBot – an Options trading app that can be of real help to take the right calls regarding when to enter the Trade & Setting the right strike price. The Algo trading engine analyses overall market movements and dozen other factors, So the trader can make accurate calls.
What are some Key Benefits of the Covered calls strategy for Trading?
- Stable Money In-Flow: The premium paid by the call buyer remains with you in case of contract expiries. So by properly setting the strike price & entering the trade at the right market price, you can manage to make frequent incomes through premiums by contract expiry.
Traders using options trading app can make accurate trade
entry-exits through the algo trading engine’s smart inputs.
- Profits in the Non-Moving market: There are long periods of time when there is almost zero to very little movement in the market. Stock prices barely move enough to book good profits. During such times, traders can make regular money through premiums paid by options contract buyers.
Because of almost no Big market movements, there will be
a high chance of Stock prices not hitting the Strike price.
How safe is the Covered Calls strategy for Trading?
From all this information, Covered calls may look like a “very easy money” strategy. Guess what? It’s not. It is very safe to go with this strategy, but there are some risk factors involved that you should keep in mind. Explained below with an example:
Let’s say you purchased Reliance energy’s stocks at ₹1,000 per unit, the current market price is ₹1,200 & strike price for the sell option contract is ₹1,500 per unit.
Now, if the strike price is hit – You walk out with ₹300 profit per unit. There are usually decent chances that the Stock might shoot up and soar much higher. In that case, you miss out on booking higher profits.
In Short: Covered calls will be Relatively safe. You can make “some” money in case of option expiries & At times the Traders can miss out on Big Profits in lieu of earning money from premiums.
Should I include Covered calls in my Regular Trading?
Short answer: Absolutely. Long answer: There are no reasons to not do so. But it will require a good amount of caution while doing so.
The difference Between In the Money & Out of the Money options also plays a role here.
By Choosing money options, you get to make a profit even in the case of contract expiries. Purely because the price of the underlying asset is moving upwards.
Here are 3 Key Factors you MUST consider before taking a (covered) call:
- Market condition (Neutral/bearish/bullish),
- Recent price movements of Particular stocks,
- Contract validity duration,
- Profit margin in case of Contract Expiry.
That’s it, All the Best for your trading journey.
