Today, we shall see how you can write the covered calls and how important it is to write the covered calls.
While writing a covered call, a trader or a contract holder possesses the right to purchase a stock that he already holds at a current price and time. Understanding it in simple terms, writing the calls means selling the call options. To enter into the options contract, the minimum requirement is 100 shares; you must have 100 shares of a particular company.
The advantage of writing the call is that you get an instant premium. As you are already the owner of the shares, you are protected if the stock price rises above the strike price. You will own the stock and also reap some profit from the premium received. Let us first understand the covered calls, and then we shall move further.
Covered calls: A financial transaction in which the owner of the underlying securities sells the call options. An investor writes or sells the options that he holds for a long term in order to get some benefit from it. Here the long-term position acts as the cover and enables the sellers to execute the transaction. An investor having a long position in an underlying asset sells call options of that underlying asset, it is called Covered call execution.
Writing covered calls is one of the best options strategies for those who want to keep their stock and maintain their portfolio for an extended period and also do not see any significant price increment in the near future. So, if you also want to preserve the strength of the portfolio while owning the underlying stock, you may employ this strategy and get premiums on your shares.
It is very important to write the covered calls correctly. Otherwise, the situation may turn upside down. So, let us see why it is so important to sell the covered calls properly and what could happen if not done correctly.
If you want to exercise a call option, you must choose the stock performing well in the current market.
There are some stocks where you do not see any significant price movement but may increase drastically in the long term. Keep those shares safe in your portfolio for future benefits.
Select the strike price at which you are ready to sell the stock without regret.
The strike price of the options should be out-of-the-money.
The reason for choosing out of the money is that you want the strike price to rise above the market price and avoid selling it.
Select the expiration date very carefully.
You may enter into monthly contacts or up to 45 days; also, use your instinct.
You should always check the date that can help you get the premium on a defined strike price.
When many alternative open contracts are available, time plays a crucial role.
As one sees more in future options, its value may get affected, making it difficult to conclude.
Always keep yourself updated with the market news and keep checking up on the price variation of the underlying stock.
So, we have seen how you can sell the covered calls and what factors to keep in mind. Now, let us go through what happens afterward. There can possibly be three situations that can occur, as below.
Stock may fall: If the strike price is lower than the current market price, then the contract will expire worthless, although you get a benefit in the form of the premium collected on it. Of course, the stock price has already dropped and was negatively impacted. Well, that's the characteristic of a covered call. Well, you have the benefit of selling the underlying stock and offsetting any potential financial risk if the stock's price has declined too much. You also have the option to liquidate your holdings and buy them again at a lower price.
Stock plateaus: This is another scenario that can happen, well that is not bad as the previous one. Your call option contract will expire worthlessly. You might gain some profit and also hold the ownership of the underlying assets.
Stock price rises above the strike price: When the Stock price rises above the strike price, then that option contract will be executed by the contract holder, and 100 shares will be sold. Suppose the price increases after you have sold them. You may feel you could have gained more, but do not feel that way. The reason you chose this strategy was enough to let you know that you have attained a profit.
Many traders use the covered calls strategy for options trading. There is no risk in selling the stocks but by holding them, as time is the matter of essence here. The more you will practice on covered calls; the sharper your skills will get. You may write to us if you have any questions regarding covered calls. Please keep visiting our website to learn more about the stock market and financial trading.