GOT YOU COVERED

Got You Covered refers to selling covered calls.  In most qualified accounts, covered calls and covered call spreads are the only option trades that can be executed. Covered calls can be used in a variety of ways which can include generating income, allowing for possible upside appreciation and provide an investor with downside protection. In addition to active traders, these strategies can prove very useful to retirees who have equity positions and want to supplement retirement income. Covered calls can also be beneficial to investors who have equity positions and want to reinvest the income generated to increase compounding. Below are a few hypothetical examples of how a covered call strategy, when utilized, can be a useful tool.

GENERATE INCOME

Buy (go long) 1000 shares of XYZ stock at 100 on October 1st  and write (sell) the November 100 call for $3 generating $3000.00. By accepting the $3 premium you have agreed to sell your XYZ stock at 100 anytime between the day you sold the call and expiration of the month the call was sold out to, in this example November.  The person who is long (bought the call) can exercise his call and your XYZ stock will be called away. Assume XYZ stock closes at 110 on November expiration, by owning XYZ stock the trade is covered which means you don’t have to go out in the open market and buy the stock at 110 and then sell the stock at 100 if it is called away, which would be very costly. By buying XYZ stock at 100 and selling the ON THE MONEY 100 call, you generate the highest possible amount of income but have no downside protection and no chance for upside appreciation.

If stock is called away at 100: 100 + 3 = 103

GENERATE INCOME WITH POSSIBLE APPRECIATION

Buy (go long) 1000 shares of company XYZ  at 100 on October 1st  and write (sell) the OUT OF THE MONEY  November 105 call for $1.00 generating $1000.00. By writing the call and receiving the $1 premium you have now agreed to sell your XYZ stock at 105 anytime between the day you wrote the call  through expiration of the month the call goes out to, in this example the third Friday of November. By being long, the XYZ stock your call is covered, which means if  XYZ stock closes at 110 on expiration you don’t have to go out in the open market, buy the XYZ at 110 then sell it at 105 when it’s called away. This would be very costly. In this example you have no downside protection but would realize any appreciation between 100 and 105 as well as the $1 premium for selling the call. You may choose to leave the $1000.00 in your account, which would essentially reduce your cost basis to 99, or withdraw the $1000.00, which can then be used as income.

If stock is called away at 105: 100 + 5 + 1 = 106

GENERATE INCOME WITH DOWNSIDE PROTECTION

Similar to the above examples. On October 1st you go long (buy) XYZ stock at 100 and sell (write) the IN THE MONEY November 95 call for $6 generating $6000.00. By accepting the $6 premium, you have agreed to sell your XYZ stock at 95 anytime between when you sold the call and expiration in November. By being long XYZ stock, you are covered if a person who is long the 95 call chooses to exercise, thus calling your stock away at 95.  In this example, you receive the $1000.00 difference between 100 where you bought XYZ, 95 where you sold XYZ  and the $6 you received when you wrote the call. You have no chance for upside appreciation here, but you have $5 downside protection.  You haven’t lost money unless XYZ drops below 94. Unlike selling OUT OF THE MONEY calls, this more conservative strategy is a great way to generate income while providing some protection against declines.

If stock is called away at 95:  100 - 95 + 6 = 101

Refer to Glossary for terms and definitions

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RISK is inherent in any investment. No individual or entity should invest with funds they cannot afford to lose. Option trading is time sensitive and involves risk including, but not limited to, loss of gains and principal. A leveraged investor risks the loss of  more than principal. Options do not have to be held until expiration and can be exercised at any point.  Option trades can be closed prior to expiration with a gain or loss being realized. It is important that you understand all trades and the risk associated before executing a transaction. The Option Profit provides broad ideas, not individual recommendations, and is not responsible for any losses incurred. Diversification is important with any strategy and should be considered when investing  Before trading consult with a financial advisor to determine if option trading is appropriate for you and your financial goals.