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WOW 22 Covered Call Revisited

Georgio Stoev, Futures and Options Product Manager

March 17, 2016

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Week 22- Agenda

Review of Demo account

Brief market watch

What are covered calls?

Demonstration of a covered call in Saxo Trader

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Market Overview (March 15th)

S&P 500 - 1%

VIX 3%

Eurostoxx -6.5%

DAX -7.3%

Nikkei -10%

EEM 3.1%

Light Crude 0.3%

GLD 15%

Bonds (TLT) 5%

FXE 2.7%

FXI -4.5%

S&P 500 Daily

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Call Put

Right to buy

Right to sell

Obligation to buy

Obligation to sell

Short (seller)

Long (buyer)

Equity option contracts give…

• On underlying security

• At the strike price

• Any time before expiration

• Option buyer pays premium

Options Rights versus Obligations

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What is a covered call?

• Own position in a stock

• Sell call option on the same stock

• The combination is called Covered Call

• Limits the investor’s upside on the underlying

in exchange for an option premium

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Why sell a Covered Call?

Many institutions and retail investors hold stock in their portfolio

Investor can partially hedge long stock position from the received

premium

By selling a call on a stock you own you reduce your cost basis in the

position

Example: You purchase 100 of XYZ stock for $100 and you

sell a call against it for $5. Your cost basis in the stock is

reduced $5 to $95.

If selling out-of-the money (OTM) investor exits stock at higher price

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Historical performance of S&P 500 covered call strategy

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Important considerations for CC

Investor expects a stock they own/buy to

rise modestly over 30 days

In order to execute CC you must own at

least 100 shares

Agree to have the stock called away from

you at the agreed price, e.g. April 30 Call

Maximum gain is limited by the April 30

Call

Reduction in cost basis = Net Investment

– Premium

Maximum loss is limited but could be

substantial (stock becomes worthless)

GE April 30 Call @ $0.40

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Setting up the covered call

Work with stocks you own or don’t mind

owning

Select a call option that is slightly,3%-

5%, above the stock price

Select an expiration, at least 30 days out

Look for return on investment (ROI) to

be at min. 2.5%

ROI = Premium + Stock

Appreciation/Net Investment or

$.39 + $1.19/28.81 = 5.5% ROI

Breakeven = Stock purchase price –

premium received ($28.81 -$ .39) = 28.42

Sell the call to open the trade/buy it back

to close

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OTM covered call example

CC breakeven at $28.42 Long GE breakeven at $28.81

Stock at expiration

27 28 29 30 31

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Management of Covered Call

Rule # 1 Exit – you can get out of the CC at any time by placing an opposite

order

Rule # 2 If GE below $30 => no action is required as the option would expire

worthless

Rule # 3 If GE above $30=> auto-exercise, share are sold at $30 and you receive

cash + premium

Rule # 4 If GE at $30 before expiration, buy back the option and roll/sell a call

for the following month

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What we learned today

Covered call is a basic options strategy where investor is long stock and short a

call

Investor is able to collect premium and enjoy some limited upside if the stock

rallies.

The risk in a CC is no different from that of just a stock ownership

The premium collected could help investors cushion some potential losses in the

stock

Buy/Write refers to buying stock and selling call simultaneously

Investors may sell ATM calls to collect larger premium

Selling covered call on monthly basis for regular income

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For next time…

Practice at least 1 covered call in the papermoney account

Watch the video from the OptionsLab page

https://www.tradingfloor.com/topics/optionslab

Sign up for WOW 23 “Using technical analysis with options

trading” special guest Kim Cramer

http://saxobank.adobeconnect.com/e86zosd90v1/event/registr

ation.html