As long as the stock is above or below your option's strike price - for the call or the put, respectively - you stand to win.īoth types of options are considered long, in the sense that both are buy positions and both let you make money on the direction of the underlying stock. In addition to being less risky, long options also include an unlimited profit potential to the upside in the case of a long call option or the downside with a long put option. And that could cause you to lose a lot of money if the stock doesn't move in the direction you expected. In contrast, in regular investing, you're committed to an actual purchase. You don't have to buy the stock (in a call) or sell the stock (in a put) unless you expect to profit - by the shares moving as you anticipated before the contract ends. Both long calls and long puts limit your loss to the premium, the cost of the options contract. Profits.Going long lets you take chances with less risk.With that in mind, here are a few cautionary points about these strategies: While covered calls and covered puts reduce risk somewhat, they cannot eliminate it entirely. Note: Chart depicts strategy at expiration. Losses could be as much as $70,000 if the stock price drops to zero, but they will always be $2,000 less than the stock trade alone.Losses will be incurred below $70 to zero. The stock can drop two points before you go into the red.If XYZ does increase above $77, the stock purchase alone would have been more profitable. So you would only want to do this if you think the price of XYZ will not exceed $77 by the April expiration. In other words, you will not have a loss unless the stock drops below $70.īut there's always a downside, and in this example the trade-off is that you limit the upside profit potential beyond a price of $77. Let's assume you:īecause you bring in two points for the covered call, it provides two points of immediate downside protection. Here's a hypothetical example of a covered call trade. It is also the maximum profit that can be earned on a covered call trade. Unless your options are deep in-the-money (ITM), that profit will usually exceed the one you would have earned if you had bought the stock outright and sold it at the appreciated price. If you sold ATM or OTM calls, the trade will generally be profitable. If the stock appreciates in value above the strike price, you'll probably have your stock called away (assigned) at the strike price, either prior to or at expiration. If you select ATM covered calls and the stock declines in value, they too should expire worthless and the outcome is essentially the same. If you select OTM covered calls and the stock remains flat or declines in value, the options should eventually expire worthless, and you'll get to keep the premium you received when they were sold without further obligation. When establishing a covered call position, most investors sell options with a strike price that is at-the-money (ATM) or slightly out-of-the-money (OTM). In many cases, the best time to sell covered calls is either at the time a long equity position is established (buy/write), or once the equity position has already begun to move in your favor. Investors typically write covered calls when they have a neutral to slightly bullish sentiment.
It’s also important to note that a covered call writer (seller) relinquishes any profitability above the strike price. If you own stock that has declined sharply in price since the purchase date, covered calls are probably not the best choice for trying to recover some of your losses. They also offer limited risk protection-confined by the amount of premium received-that can sometimes be enough to offset modest price swings in the underlying equity. When it’s structured properly, both time and price can work in your favor.Ĭovered calls are one of the most common and popular option strategies and can be a great way to generate income in a flat or mildly uptrending market. What is a covered call?Ī covered call is when you sell someone else the right to purchase a stock that you already own (hence “covered”), at a specified price (strike price), by a certain date (expiration date). When employed correctly, covered calls and covered puts can help manage risk by potentially increasing profits and reducing losses simultaneously. Principles can help you reach your financial goals.
$0 online equity trade commissions + Satisfaction Guarantee.
ADRs, Foreign Ordinaries & Canadian Stocks.