Strategy

Covered call

Buy-Write

Type of Strategy

trading / investing

sentiment

bullish / neutral

implied volatility

high

example

{OTM CC}:  xyz at $50.  Sell a 45-dte $55 strike call for $2.

boundaries

max loss = $48 ($50-$2)     

max profit = $7  ($55-$50+$2)

Breakeven = $48     (underlying – credit recvd)

description

While owning the underlying stock position, sell a call option against the shares.  The call sold can be ITM, ATM, or OTM based on seller’s intent.  The term “Buy-Write” is often used for a covered call when the call is sold concurrent to the equity purchase.

Set-Up

While holding an equity position, sell a call option against the shares that effectively limits the realized price appreciation of the stock. Generally, covered calls are written ATM or OTM. Selling covered calls does not add risk to the investment. Rather, the risk profile is diminished by the value of the call sold. Writing covered calls against a position effectively reduces the cost basis of the position.

Soi perspective

When writing covered calls against equity positions, the seller should confirm a willingness to sell the shares at the strike price of the written option contract.

Generally, covered call strategies perform well for lower priced equities with high implied volatility.  Research generally points to an optimal 45 DTE option with a 30-delta strike providing a good balance between capital appreciation opportunity and premium collection.

Note that covered calls can often be rolled out and up provided the equity has not outstripped the call strike price.  Once the equity has significantly eclipsed the strike price, it is often better to let shares be called away and consider starting with a new position in the underlying.

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