Writing a covered call
by Tushar Mathur - December 23rd, 2009. Filed under: Trading.Covered call option is for those who believe in the maxim ‘Slow and steady wins the race’. Though you may not make huge profits on any single day, you would undoubtedly make steady profit from the stocks that you own.
The greatest advantage of covered call is that you are limiting your risks.
Let us see how you can write a covered call:
First, you need to get clarification from the brokerage service whether they offer covered call options for your stock.
In case, your present brokerage service do not cater to covered call, you need to find a brokerage service that offer you covered call option, and get your stocks transferred to them.
All your stocks may not be eligible for covered call. Only top cap stocks are eligible for covered call. To write a covered call, you will require 100 shares for which you want to write covered call.
The most important aspect is deciding the strike price for covered call. You need to maintain a balance between risk and the profit. The balance between high out the money and at the money strike is crucial to earn respectable margins. While at the money strike may be risky, it would earn better profits, whereas, high out the money is safe but has low margins.
Ideally your aim should be to have the stock and at the same time keep on pocketing the increase in the value of the stock. The price should not be more than the strike price of call option.
Next, you have to decide on the expiry month. If you choose a further month, then the call will be costly, but you would be selling call and earning premium. But, it should be remembered that when you have very long option period, you are providing time to the buyer the option of ‘in the money’.
While selling, you need to sell with ‘sell to open’. When you do this, your account gets credited instantly. This will enable you to earn the entire premium on the stock.
In case the price of your stock is heading north, and is almost reaching the strike price, then you place ‘buy to close’.
In the worst situation, your may have to sell off your stock of 100 shares if the stock is called away.