- When should an investor use a cover call?
- Is it a profitable strategy?
- Is this strategy low in risk?
All those new or even experienced traders should make their way to experience the beauty of the covered call (CC) trading method. Thus, it is put together through the involvement of a trader writing a certain call option in opposition to that asset. This stock is the one that the broker has purchased or has held in hand.
Through CC, investors can earn few premiums for sale and gain high benefits on the purchased assets. This process plays a major role in making massive profits on an investor’s specific stock.
What is the covered call options strategy?
A CC is defined as a two-part strategic trading process. Under this, assets are either owned or are purchased. On the other side, calls are generally sold based on share-for-share.
Buy write is the term used to describe the action for buying a stock. Overwrite is the term that defines the action to trade the calls against the asset which the investor has purchased previously.
Any trader within the naked call position thinks that the asset stays neutral to simply bearish the shortest scenario.
Nevertheless, CC provides mild security shortcoming for various assets and thus generates high income for that trader.
When should an investor use a cover call?
The method has an expiration limit that stays for a maximum of 50 to 60 days. In this way, a trader will take some advantage of time decay. But, of course, it all rests on investors’ objectives and how correctly they are about to implement their trading.
An investor should always be concerned about trading the calls, which is the main objective. Then, later on, a small sum of money can be made through the asset they have bought or are already handling. But in a manner, how you are using the method is completely based on the asset price and strike price.
What is a buy-write strategy in the covered call?
Some investors sell the call and buy the shares simultaneously. This process is known as the buy-write method. With this trading way, an investor can reduce the risk of some newly acquired assets.
There are no further requirements about the margin for shares purchased under the coverage prerequisite. However, if you trade a call, the corresponding premium is generally 2% of the stock’s current value. You can compute this by dividing the premium amount by the value of a stock.
It is vital to calculate how much you can get out of this trading way and establish a premium accordingly. As a result, traders get a huge bonus by shortening their options. However, this is only possible if the implied volatility is slightly higher.
Under such conditions, some traders are happy to hold shares. They then sell-off call options at a higher premium to refrain from any risks associated with their stock valuation.
Is it a profitable method?
A CC method is as gainful for some investors as any other trading methodology. However, the maximum return on a CC will be when the stock price rises to the specific starting price of the call that the trader had liquidated.
Like any other method, a CC has its pros and cons. It can help if the investor uses it with specific stocks. The traders can only profit from a small rise in the price. So, this is a great way to lower your average expenses or increase your income.
Pros of covered call strategy explained
- It helps spawn some supplementary income from the shares you have owned. As you sell the CC, the traders obtain the premium payment from a specific buyer. This CC method is also helpful in making you earn some income through the time of trading a call.
- Plus, it even helps you set the target for an offered price for the asset you have owned. Thus, an investor can aim the offered price much higher than the present price in the market.
- Risks are a bit infinite. Even in the worst scenarios, the stock will drop to $0, and the shares will get completely worthless.
Cons of covered call strategy explained
- It will limit the probable profit once the asset’s future price rises. As a result, it will only allow you to make a premium by selling the CC.
- Net gains are subject to certain taxes. An investor should be paying the long-term or near-term capital gain taxes based on different factors.
Is this strategy low in risk?
Very low risk is witnessed in the CC. But the CC will limit the further probability of higher profit if the asset continuously rises.
With CC, traders can earn some premium for selling and access some additional benefit on the price of underlying assets towards a certain strike price. Investors generally use this to make huge profits on their assets when the trade market gets completely flat.
Unlike the CC, call sellers are known to be the naked call writers because they do not own the corresponding sum of underlying assets. If the underlying share jumps, these naked short calls will also experience an unlimited probability of losing.
Final thoughts
To end with this whole discussion, we will once again repeat that CC or buy-write is a two-part method in which the assets are bought. Then, later on, the calls are sold based on share-for-share.
There are three major benefits that investors can gain from CC. First, there is an income neutral to the bullish markets and smaller downside protection.
The traders must be capable of holding an underlying asset. They should be capable of selling the share at the right price. If the asset price has declined below the level of the break-even point, then the losses will start to emerge in the CC.