A lot of options traders are already writing covered calls for a living. That is not a surprise as a covered call is one of the best strategies for options trading beginners. Because of it’s simplicity this trade is wildly popular among retail traders. Writing covered calls is quite low risk. However you can’t ignore the dangers. In this blog post we will teach you all you need to know. In order to start making this trade for yourself. First things first…
What’s a covered call
A covered call strategy is made of:
- Long position in the underlying instrument
- Short call option position on that instrument
That’s it. You can see how simple this is. However note that you need to have an adequate amount of underlying. For example if you sold one stock option call on XYZ company. You will need to hold 100 shares of XYZ as 1 stock option is corresponding to 100 shares.
Writing covered calls for a living: risk profile
The potential loss of a covered call is equal to the potential loss of the underlying minus the premium received. The maximum profit is the difference between strike price and the underlying price at the opening of a trade. Plus premium collected. Provided that the underlying price was below strike price. Otherwise it’s equal to the premium of call at the start. Therefore it could be said. That the covered call is safer than a long position. The trade off is the limited max profit. There also one more risk. The exercise risk. However if you hold enough of the underlying. As advised above. You don’t have to worry about it. Just remember that your position could be gone before expiry date.
Pay off diagram
Here is a graphical illustration of the risk profile:
Writing covered calls for a living, what returns to expect.
As a general rule of thumb. When you are writing covered calls for a living. You can expect to get similar returns as if you were trading the underlying directly. Your risk, profits and losses range will depend on the volatility of the underlying. But with a covered call you will profit more often. The losses will be smaller. And the profits will also be smaller. As you get better at picking strikes and expiry. Your returns may actually be bigger. Than when trading underlying directly. That is because of lower loses on losing trades.