Welcome back! Today, I'd like to explain what a Covered Call is, and why this strategy should be part of your portfolio.
This strategy does require a larger amount of capital to begin when compared to Buying Calls alone, but I would consider it to be a more "conservative," it all circles back to your risk tolerance.
To begin, I hope you read the part about Buying Calls, if you have not, I recommend doing that first. That information is incredibly helpful when trying to visualize what this all means.
Step 1: Find a company that you are excited about, wouldn't mind owning for the long term, and is reasonably priced (again this depends on your capital and how much money you want tied up in a single company).
I am going to use Luminar Technolgy (LAZR) for this example. LAZR is an autonomous vehicle sensor and Lidar Technology company. LiDaR (Light Detection and Ranging) is sonar used to detect the surroundings around the vehicles. I'm into the EV space as it has been emerging, which has been a thread if you read through the strategies and other post.
To create the conditions required to sell covered calls, you first need to buy 100 shares of your choice company (Or in Increments of 100, as you will see).
**Remember when we are BUYING Calls, we are buying the option to purchase 100 shares of a company at the Strike Price. Selling calls, is just the other half of that transaction.
You are Selling someone the option (and right) to buy 100 shares of your choice company FROM YOU at the Strike Price. This is why you need to hold the shares. An example will make this much more clear:
I purchased 200 shares of LAZR at an average of $29.82 per share, for a total initial investment of $5,964. Currently (Jan 12, 2021) LAZR is sitting at $31.30 a share, netting me unrealized profits of a whopping $296.
Step 2: Selling Covered Calls on your Shares
When we are BUYING calls, puts, and Bull Call Debit Spreads, we always want the date to be as far away as possible, this provides us the most protection in the event of a market drop. Patience.
When we are SELLING calls, we want the soonest expiration date possible, because our intent is that the calls expire worthless (for the buyer, remember, we are the seller here). Navigate to your options window, make sure that you have selected to "Sell" a "Call", and now you are seeing the sell side of options.
Let's use the $34 Sell Call for the example in the "Sell a Call" link above, with the expiration date of 1/15/2021, this coming Friday. The $34 strike, with a price of $0.80, represents how much someone will PAY YOU for the option to buy your shares, on or before January 15, 2021 for $34 a share. Remember that $0.80 x 100 = $80 (options are always multiplied by 100).
That means someone is willing to pay me $80 per contract I sell, and if LAZR climbs over $34 by Friday, the person who bought my Calls has the option to "call away" my shares, no matter what the price of LAZR is at the close. They would never do this under $34 a share, because they can buy them on the open market cheaper, this is only a bad trade if LAZR decides to climb to $100 a share by Friday, and I have to sell them for $34 a share based on the contract. If LAZR is under $34 a share on Friday, I would keep the $80 premium they paid me, and I would keep my shares, allowing me to sell another covered call.
That's all there is to it. Here is my Real Life Example, which I hope will pull all that information together.
I have 200 shares of LAZR, which means I can sell 2 Covered Calls.
Shares - 200 ($29.82 average, total investment $5,964)
Option Strategy - Selling a Covered Call
Option Expiration Date - 1/15/2021
Strike Price - $38.50 - This means that if LAZR closes above $38.50 on Friday, whoever purchased my option will, more than likely, call away my shares. I paid $29.82 per share ($2982), if this call was exercised due to it being over $38.50 on Friday, I would be paid $3,850, not including the premium from selling the call you also keep, for a net profit of $968. If LAZR closes on January 15, 2021 below $38.50 per share, I keep the premium and my shares.
The Trade - I sold 1 call for $1.00 x 100 = $100 premium (I did not sell 2 because I didn't want to get caught with all my shares tied up incase it skyrocketed for some reason). When selling Calls, the plan is expiration at a price lower than your Strike Price, my $38.50 sell (I was paid $100 in premium) is currently worth $10, quickly on its way to $0, I keep the premium and the shares.
The Plan - I plan to hold my shares as long as possible. Call premiums skyrocket when there is volatility, and that is what I will wait for. The next time LAZR spikes up to $35-$37 a share, I'll sell higher calls, like $42 a share, and collect more premium. If the stock ever reaches the strike price, I make a noice gain per share, if not, I keep selling calls for premium until they do. If the stock crashes, you have the support of time for recovery, since you are holding the shares.
Please let me know what you think. Head over to the groups section and let me know what Option Strategy you want to learn more about and I'd love to write something up!
Good Luck out there!
Kevin Parker
Retail Trader
Dreamer of Financial Freedom