Like any tool, it can be tremendously useful in the right hands for the right occasion, but useless or harmful when used incorrectly. And, of course, covered calls can be sold on etf’s of other asset classes that often move counter to stocks, such as bonds, or sometimes gold. Make Money By Spending Less. They should be considered based on your own situation and commission structure. The option buyer didn’t exercise the option since the market price of the stock on expiration day is below the strike price. Again this is where deep in the money calls as a strategy for bear markets can be a winning strategy. And then the game is over. . Everyone knows what deep in the money calls means. Sell a deep in-the-money strike with a 2% time value premium and downside protection of that profit; … Click here to get my eBook with our favorite 9 income generating strategies that build wealth, too. I like to assess this from a stock chart, as well as fundamentals such as earnings and dividends, while also factoring in the risk I am willing to accept. It makes more sense—instead of buying 500 shares of ABC stock at $60 (for $30,000)—to buy five of the ABC Jan 45 calls … Second, if you’re selling out of the money covered calls in down trending markets, those out of the money covered calls are unlikely to get exercised. Investopedia uses cookies to provide you with a great user experience. RMBS closed that day at 38.60, and there were 27 days left in the May options cycle (calendar days to expiration). ♦Wealth Building Tip♦ All investments are bad if they take an investor outside of acceptable risk while too little risk can hinder investment returns. sell covered calls in IRA’s to eliminate, defer or reduce taxes. Looking at the May 25 strike, which is in-the-money by $13.60 (intrinsic value), we see that there is some decent time premium available for selling. Fortunately, there are some advanced covered call management strategies that can be used during stock market downturns. Before deciding whether to use an out of the money, at the money, or an in the money covered call strategy, consider the above factors, overall stock market direction and your own financial goals for building wealth or income. There is a trade off for this income, however, and more to consider as explained below. Note that since the stock price has dropped from her purchase price of $18.50, the income generated will not be as good as the prior month since the stock price (and related option) is lower. This is simply because when an in the money covered call is exercised, the option seller has to sell the stock at a lower (strike) price with an in the money covered call than an out of the money covered call. The good thing for covered call investors is that stock and option commissions have gotten very cheap over the past two decades due to competition, especially with the ability to buy and sell securities online. But there is very little downside protection, and a strategy constructed this way really operates more like a long stock position than a premium collection strategy. . This phrase applies to both calls and puts. Selling Deep In The Money Calls Example Let's say you like McMoRan Exploration (MMR, oil & gas company). So, by owning 600 shares of Retire Corp, Alex was able to sell the 6 option contracts. The formula for calculating maximum profit is given below: You’ll want to decide if you prefer that your covered calls get exercised or not. of $18 so there would have been no reason to exercise the option. ♦Risk Management Tip♦  All investors will want to confirm that investing in stocks is within their own acceptable risk level before even considering using any covered call strategies. Also remember that bear markets have, in hindsight, usually been. stick with me because it’s important because it makes the math on in the money covered call strategies easy to understand. This was the market price when she sold an in the money call option for $1.40 with an $18 strike. ♦Income Stream Tip♦  Selling call options on high dividend stocks can make sense for investors who always want at least a little income from stocks. Read my related post How to Create a Wealth Plan that explains this more. Selling covered call options is a powerful strategy, but only in the right context. than out of the money covered call strategies. After a covered call is exercised, the capital used to own the stock is available for new covered call positions. This is because the entire position can be entered into based on the optimal income initially. The income generated from selling covered calls usually ranges at least two to twenty times that of typical dividend income! Hire a financial professional if you think you need one. Sometimes you can even find a deep in the … Proposed strategy. Let’s compare how each perform in declining stock markets. Again, it’s important to first note that investors who own stocks without covered calls, especially stocks that don’t pay dividends, also suffer during bear markets. Instead of selling another call option right after option expiration, Alex can watch the stock chart with the plan to sell a call option near the top of the current trading range to get a higher option premium. Note that if you’re new to stock charts, while technical analysis can seem daunting, very basic technical analysis can be an incredibly valuable tool for evaluating the best covered call strategies. Clearly, the risk/reward seems misplaced. This gives the call purchaser the right to buy the stock from Alex at $18 on the third Friday of June (option expiration), or June 15 in that particular year. They should be considered based on your own situation and commission structure. Assume the option buyer did not exercise the option by buying the stock. Nevertheless, covered call strategies work best and are the easiest to implement in sideways or upwardly trending markets. In this case, Alex would have made $800 from selling the call options. A ratio call write is an options strategy where one owns shares in the underlying stock and writes more call options than the amount of underlying shares. Stop losses can be set to significantly lower stock risk when selling covered calls. The maximum return potential at the strike by expiration is 52.1%. Therefore, we have a very wide potential profit zone extended to as low as 23.80 ($14.80 below the stock price). Below are the other factors for when to use an in the money covered call strategy, so keep reading. In this case, the option buyer may or may not “exercise” the call option. One of 3 things could happen at option expiration as outlined below. Get my free eBook with our top 9 strategies to build wealth while generating income. While the underlying stock price will have drop by the dividend amount, the written call options will also register the same drop since deep-in-the-money options have a delta of nearly 1. market price when she sold an in the money call option for $1.40 with an $18 strike. Alex can sell another call option for the next month against her shares in Retire Corp. ince the stock price has dropped from her purchase price of $18.50. Read my related post to see how a stock market crash will affect you. Traditional Covered-Call Write Let's look at an example using Rambus (RMBS), a company that manufactures and licenses chip interface technologies. y owning 600 shares of Retire Corp, Alex was able to sell. That … Investment capital allocated to covered call selling can get completely tied up with little if any income from stocks during bear markets. Likewise, new covered call trades each month tend to generate more income, easier. And this happens immediately after the call option is sold against the stock. When found, an in-the-money covered-call write provides an excellent, delta neutral, time premium collection approach - one that offers greater downside protection and, therefore, wider potential profit zone, than the traditional at- or out-of-the-money covered writes. Either way, Alex kept the $800 from the option sale. As the striking price is lower than the price paid for the underlying stock, any upward price movement will not benefit the call writer since he has agreed to sell the shares to the option holder at the lower striking price. It closed at $17.16. You can see why covered calls can be a great income generator for stock investors who are already exposed to stock market risk anyway. or out of the money covered call strategy. Sell a Call Option After Stock Rises. . And after investing in stocks for almost 40 years, I’ve learned the importance of addressing risk management before even considering any investment, so let’s do that first. Now that risk from covered call strategies has been addressed, and how in the money covered calls can be the least risky strategy, lets’ see how an in the money covered call strategy, specifically, works, as opposed to other covered call strategies. As you saw in the example above, an in the money covered call strategy is commonly used when: Below are several important factors to consider, however, before using an in the money covered call strategy. If used with margin to open a position of this type, returns have the potential to be much higher, but of course with additional risk. Read my related post Does Living Off Covered Calls Really Work? ers living off investments who count on covered calls for income, bear markets can present a real challenge. It’s a fool’s errand. Keep in mind this is income from one month’s profit from just one covered call position. Any upside move produces a profit. This allows you to sell call options repeatedly against the same stock position, thereby reducing the need to find additional suitable stocks. Buying options is a lot like gambling at the casino. Option 2. Likewise, offset, however, by the reality that managing unexercised covered calls, doesn’t generate as much income as new monthly trades. Here is an example of an in the money covered call strategy. For a more comprehensive breakdown on the different strategies Click Here To Read… Selling Options To Boost Your Income . ♦Income Stream Tip♦  The same stocks can be used for covered call strategies repeatedly, sometimes around dividends or earnings news. Remember, the higher income trade off with in the money covered call strategies is that the stock can be called at a loss. Selling in the money covered calls can be an excellent, In the money covered calls, however, tend to be the. In the money covered calls, however, tend to be the least risky of the three covered call strategies, and here’s why: In the money strategies offset stock cost more than other covered call strategies because the covered call writer gets the highest premium when selling in the money options, as explained ahead. Most investors just assume selling covered calls is risky since it involves options. This is why it’s the strategy at Options … Let’s look at the third possible outcome at option expiration with her Retire Corp in the money covered call strategy. The primary risk in this strategy is that the underlying stock may move further downward. But the good thing is that Alex gets to keep the $ 1.40 for selling the option, which reduces her Retire Corp position cost per share cost to $17.10. However, in order to compare a monthly or six week return to an annual return, such as dividend income of 3% a year, it helps to calculate covered call returns annualized. aving all your covered calls exercised each month provides capital for fresh positions, without having to allocate more capital to stocks designated for covered calls. Read Trade The Covered Call - Without The Stock.). That's over three times what highly rated bonds pay. This is why I often write that selling covered calls can be an ideal income stream for investors who already have stock market risk in their portfolio anyway. As you can see in Figure 2, with the May 25 in-the-money call write, the potential return on this strategy is +5% (maximum). Of course, there is no way to know this with certainty but the stock chart can provide probabilities. They are addicted to the thrill of the game as they continue to look for that next explosive trade. A fence is a defensive options strategy that an investor deploys to protect an owned holding from a price decline, at the cost of potential profits. ♣  It’s super important to remember that when you sell in the money covered calls, you know that you may have to sell the stock at a loss. (Pardon the irresistible pun.). Selling call options below a stock’s cost can result in selling the underlying stocks at a loss. The near … For options, both a call and a put option can be in the money. she is okay with that since she did the math, for all 3 possible option expiration outcomes, can be a great income generator for stock investors. Therefore, the maximum gain to be made writing in-the-money calls is limited to the time value of the premium at the time of writing the call. This lower basis (adjusted stock price) can also serve as a good place for a stop loss to lower investment risk from stocks. Selling call options against shares you already hold brings in guaranteed money right away. The worse thing for covered call writing is, bear markets so let’s see how bear markets affect in the money covered call strategies when compared to other covered call strategies. In this scenario, Retire Corp closed at exactly $18, or at the money. Required fields are marked *. Selling in the money covered calls can be an excellent income generating strategy for those living off investments. Remember, the prior month, the stock was at $18.50. One of the most popular short trading methods is selling out-of-the-money … If increasing stock income by selling covered calls is the primary objective, it’s worth considering in the money covered call strategies. Otherwise, I’d sell an out of the money covered call. Figure 1 - RMBS May option prices with the May 25 in-the-money call option and downside protection highlighted. It’s important to note that Alex immediately got $800 deposited into her brokerage account for the sale of the options which she gets to keep regardless of what the stock price does. Plus, … It involves writing (selling) in-the-money covered calls, and it offers traders two major advantages: much greater downside protection and a much larger potential profit range. Remember, the further away the strike price is above the current stock price, the less income generated since the option premium (price) gets lower as it moves further up and away from the stock price. Risk is permanently reduced by the amount of premium received. Looking at another example, a May 30 in-the-money call would yield a higher potential profit than the May 25. DISCLAIMER: Nothing in this post is meant to be taken as personal financial advice. A collar, commonly known as a hedge wrapper, is an options strategy implemented to protect against large losses, but it also limits large gains. If so, this loss will offset the income generated from selling the call option as explained more ahead. Cash collected up front can be … Ali’s example gives you a basic and broad idea of why a covered call seller may choose an in the money covered call strategy. Option premiums were higher than normal due to uncertainty surrounding legal issues and a recent earnings announcement. This article is going to cover selling deep in the money (ITM) puts. Because 90% of traders who buy options without having an edge lose money. Also remember that bear markets have, in hindsight, usually been excellent opportunities for covered call strategies once a sideways or bull market resumes. And then the game is over. * ABC Jan 50 calls trading at $15 (These are in the money by two strike prices.) Ali already made a nice $2 per contract for the call option she sold. On that strike, there is $260 in time premium available. Again, it’s important to first note that investors who own stocks without covered calls, especially stocks that don’t pay dividends, also suffer during bear markets. . As you can see in Figure 1, the most attractive feature of the writing approach is the downside protection of 38% (for the May 25 write). are profitable, but many are, and they can be an excellent income source. Instead of selling another call option right after option expiration. With this in mind, she decides to sell a call option with a $99 strike for $2 instead of a call option with a $100 strike for $1.50 agsint her Income Streams, Inc. shares. This strategy is commonly used when the call writer expects the stock price to decrease, or to increase the probability of the option being exercised. Contrary to popular belief, selling covered calls slightly reduces stock risk over owning stocks outright without a covered call strategy sold against them. Why? Alternative Covered Call Construction As you can see in Figure 1, we could move into the money for options to sell, if we can find time premium on the deep in-the-money options. For further reading, see Come One, Come All - Covered Calls. At the time these prices were taken, RMBS was one of the best available stocks to write calls against, based on a screen for covered calls done after the close of trading. Option 3. The reality is that all covered call strategies are subject to overall stock market risk, as well as stock specific risk. Now back to Alex and her covered call position on Retire Corp. There is, You’ll want to decide if you prefer that your covered calls get exercised or not. By writing short-term deep in the money calls on blue-chip stocks, a conservative investor can earn 6% to 9% a year without taking much equity risk. How Does an In the Money Covered Call Strategy Work? On the other hand, managing covered calls is probably a little less work than finding new covered calls to sell every month. The option buyer could simply buy the stock for less than the strike price of $18 so there would have been no reason to exercise the option. And who doesn’t want higher income for the same amount of capital at risk? ♦Wealth Building Mindset♦ Always evaluate potential best and worst case investment outcomes, then accept and learn from what occurs. Alex can simply sell the stock and close the position. As you may have guessed, not all in the money covered calls investments are profitable, but many are, and they can be an excellent income source. Trade deep in-the-money calls to increase yield on a stock and lower the downside risk. Been no reason to exercise the option expiration stocks outright without a covered call trades month..., Alex kept the $ 800 from the option expiration date, the prior month, the capital to. 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