Two ways to open the trade
We want to buy low and sell high by buying stocks when weak and selling calls when strong. We can also sell puts on weakness as an alternative to buying stocks. The Profit and Loss graph for selling a put is the same as for selling a covered call.
If we sell puts, we will likely have put shares for us at some point and then hold the shares at the strike price we sold less any premiums received. Offering us stock at a reduced cost is part of the plan. When we sell an out-of-the-money (OTM) put option, we methodically push the statistics in our favor by “buying low” when the underlying declines. We can alternatively think of selling a put as a limit order to buy shares with a limit price equal to the strike price we sold.
When shares are “put” to us, we then sell call options against the shares we currently own. And the cost (or basis) of the shares we bought will have been reduced by the cumulative option premium collected by selling puts.
Business management
We may not have a great opportunity to sell option premiums in all possible cycles. There will likely be times when the underlying pulls back, and we may want to wait for the price to recover before selling calls. Actual expiry cycle results are likely to be a mix of having worthless expire calls in some cycles and having stocks called in other cycles.
Writing covered calls is a relatively low-maintenance strategy that does not need to be constantly monitored. Once we write calls, actions will either be called or not. But we have to be patient and let time degrade into the options we sold.
If the calls we sold expire worthless, we still own the shares. In this case, we sell calls again for a future expiration cycle and collect more option premium.
If our call options expire in the money (ITM), the call options will be exercised and the shares will be repurchased. The shares are purchased by our counterparty at the strike price that we sold, and we no longer own the shares. As a Call seller, we keep the premium and any gain on the shares. In this case, we start the process again by buying shares or selling puts.
Upside and Downside Risks
Writing covered calls (and selling puts) is a neutral to bullish strategy. There may be sustained downtrends, price shocks and changes in volatility which may affect the performance of the strategy. As with any strategy, it is important to ask and understand “What could go wrong? before getting involved.
There is always a trade-off when writing covered calls. In exchange for collecting the option premium, the profit is limited to the amount of the premium collected plus any stock appreciation up to the strike price. For this reason, I tend to sell calls out of the money (OTM).
Keeping the probability in our favor and letting the decay of time work for us are advantages of selling a Covered Call (or Put). As options sellers, we don’t need big moves to make a profit. We have the statistical odds in our favor and option time decay works for us. The price of the underlying stock can rise, sideways or even fall a little, and we can always profit from it. The “synthetic dividend” is one of my favorite ways to generate repeatable profits.
What else should you know about options trading?
Every day on Options Trading Signals, we conduct defined risk trading that protects us from black swan events 24/7. Many may think that is what stop losses are for. Well, remember that the markets are only open about 1/3 of the hours a day. Therefore, a stop loss only protects you for 1/3 of each day. Stocks can go up or down. With options you are always protected because we define the risk in a spread. We cover with multiple legs, which are always on once you own.
If you are new to trading or have traded stocks but are interested in options, you can find more information at The Technical Traders – Options Trading Signals Service. Chief Options Trading Specialist Brian Benson, who has been trading options for almost 20 years, sends real live trade alerts on real trades, such as TSLA and NVDA, with real money. Ready to subscribe, click here: TheTechnicalTraders.com.
Enjoy your day !
Chris Vermeulen
Founder and Chief Market Strategist
TheTechnicalTraders.com
Comments are closed.