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Option Fundamentals: Covered Calls

SourcesSources Member, Swaye's Wigwam Posts: 3,793
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Swaye's Wigwam
edited May 2022 in Tug Tavern
I think the general sentiment of the board here is to take a long view (shout out to my JACKS) on investments. In view of this, I thought it'd be helpful to cover an easy way to generate income while holding equities long term: covered calls.

What is a call?

To understand a covered call, you have to understand what a call option is first. I'm too lazy to come up with a definition, so here is one off of the internet:

Call options are financial contracts that give the option buyer the right, but not the obligation, to buy a stock, bond, commodity or other asset or instrument at a specified price within a specific time period. The stock, bond, or commodity is called the underlying asset. A call buyer profits when the underlying asset increases in price.

https://www.investopedia.com/terms/c/calloption.asp

More specifically, options are a "derivative" because their entire existence and price action is derived from an underlying equity. Each call option gives the holder the right to buy 100 shares of a company at a specific price, known as the strike price, up until a specified date, known as the expiration date. If, for instance, you have a TSLA call option for $800, you can buy TSLA for $800 at any time prior to expiry of the option. If TSLA is less than $800 at expiry, the option expires worthless. If not, the option is executed at the $800 strike price.

The market price of the call option is the "premium". It is the price paid for the rights the call option provides. If at expiry the underlying asset is below the strike price, the call buyer loses the premium paid.

Covered Call

Rather than buying call options, one can sell calls as well. A covered call is the sale of a call option in which the investor selling owns an equivalent amount of the underlying security (100 shares per option contract). This way, if the price of the underlying stock goes above the strike price, the shares are sold to the buyer at the strike price. The seller then receives the premium plus any increase in the stock price up to the premium (if any).

What does all this Wall Street bullshit mean for you?

If you own shares and have no plan to sell, you can sell covered calls far out of the money (essentially no chance that the price of the underlying stock reaches the strike price) and collect premiums on a periodic basis. By way of example, TSLA closed at $718.99 today. At that time, a $900 call with a 5/21 expiry was priced at $935 (9.35 x 100) and has a 10.09% chance of ending up in the money. If TSLA fails to reach $900 by 5/21, the entirety of the $935 premium goes to the seller, for a 1.3% profit in roughly a month (at which time you can repeat the process). If TSLA reaches $900, the seller gains the $935 premium and sells 100 shares of TSLA at $900 for a much larger gain (but loses the shares and may have not wanted to).


This is a pretty rough justice explanation, but hopefully serves as a good initial exposure for some folks to put your equity to work. Happy to answer any questions and can do a part 2 that covers the role of the "greeks" in options that dictate the price and price fluctuations of options resulting from changes in price of underlying stocks and volatility, etc.

Comments

  • BasemanBaseman Member Posts: 12,365
    First Anniversary First Comment 5 Up Votes Combo Breaker
    edited April 2021
    Sources said:

    I think the general sentiment of the board here is to take a long view (shout out to my JACKS) on investments. In view of this, I thought it'd be helpful to cover an easy way to generate income while holding equities long term: covered calls.

    What is a call?

    To understand a covered call, you have to understand what a call option is first. I'm too lazy to come up with a definition, so here is one off of the internet:

    Call options are financial contracts that give the option buyer the right, but not the obligation, to buy a stock, bond, commodity or other asset or instrument at a specified price within a specific time period. The stock, bond, or commodity is called the underlying asset. A call buyer profits when the underlying asset increases in price.

    https://www.investopedia.com/terms/c/calloption.asp

    More specifically, options are a "derivative" because their entire existence and price action is derived from an underlying equity. Each call option gives the holder the right to buy 100 shares of a company at a specific price, known as the strike price, up until a specified date, known as the expiration date. If, for instance, you have a TSLA call option for $800, you can buy TSLA for $800 at any time prior to expiry of the option. If TSLA is less than $800 at expiry, the option expires worthless. If not, the option is executed at the $800 strike price.

    The market price of the call option is the "premium". It is the price paid for the rights the call option provides. If at expiry the underlying asset is below the strike price, the call buyer loses the premium paid.

    Covered Call

    Rather than buying call options, one can sell calls as well. A covered call is the sale of a call option in which the investor selling owns an equivalent amount of the underlying security (100 shares per option contract). This way, if the price of the underlying stock goes above the strike price, the shares are sold to the buyer at the strike price. The seller then receives the premium plus any increase in the stock price up to the premium (if any).

    What does all this Wall Street bullshit mean for you?

    If you own shares and have no plan to sell, you can sell covered calls far out of the money (essentially no chance that the price of the underlying stock reaches the strike price) and collect premiums on a periodic basis. By way of example, TSLA closed at $718.99 today. At that time, a $900 call with a 5/21 expiry was priced at $935 (9.35 x 100) and has a 10.09% chance of ending up in the money. If TSLA fails to reach $900 by 5/21, the entirety of the $935 premium goes to the seller, for a 1.3% profit in roughly a month (at which time you can repeat the process). If TSLA reaches $900, the seller gains the $935 premium and sells 100 shares of TSLA at $900 for a much larger gain (but loses the shares and may have not wanted to).


    This is a pretty rough justice explanation, but hopefully serves as a good initial exposure for some folks to put your equity to work. Happy to answer any questions and can do a part 2 that covers the role of the "greeks" in options that dictate the price and price fluctuations of options resulting from changes in price of underlying stocks and volatility, etc.

    If you're long Tesla now sell the April 30 $750 call and collect $25. Implied volatility is nearly 80% and will decay rapidly.

    If you get called away @ $750 take your $775 ($750 + $25 premium) and skip away.

    Or you could go exotic, sell the April 30 $750 call collect $25, sell the April 30 $650 put and collect $12, then buy the May 14 $650 put for $23.

    Net, net you collect $14 and you have protection if the stock drops 7% or more. If Tesla goes lower the near term put will decay quicker.

    I wouldn't own Tesla, but if I did, that's how I would protect it and collect some premium.
  • SourcesSources Member, Swaye's Wigwam Posts: 3,793
    First Anniversary 5 Awesomes First Comment 5 Up Votes
    Swaye's Wigwam
    Baseman said:

    Sources said:

    I think the general sentiment of the board here is to take a long view (shout out to my JACKS) on investments. In view of this, I thought it'd be helpful to cover an easy way to generate income while holding equities long term: covered calls.

    What is a call?

    To understand a covered call, you have to understand what a call option is first. I'm too lazy to come up with a definition, so here is one off of the internet:

    Call options are financial contracts that give the option buyer the right, but not the obligation, to buy a stock, bond, commodity or other asset or instrument at a specified price within a specific time period. The stock, bond, or commodity is called the underlying asset. A call buyer profits when the underlying asset increases in price.

    https://www.investopedia.com/terms/c/calloption.asp

    More specifically, options are a "derivative" because their entire existence and price action is derived from an underlying equity. Each call option gives the holder the right to buy 100 shares of a company at a specific price, known as the strike price, up until a specified date, known as the expiration date. If, for instance, you have a TSLA call option for $800, you can buy TSLA for $800 at any time prior to expiry of the option. If TSLA is less than $800 at expiry, the option expires worthless. If not, the option is executed at the $800 strike price.

    The market price of the call option is the "premium". It is the price paid for the rights the call option provides. If at expiry the underlying asset is below the strike price, the call buyer loses the premium paid.

    Covered Call

    Rather than buying call options, one can sell calls as well. A covered call is the sale of a call option in which the investor selling owns an equivalent amount of the underlying security (100 shares per option contract). This way, if the price of the underlying stock goes above the strike price, the shares are sold to the buyer at the strike price. The seller then receives the premium plus any increase in the stock price up to the premium (if any).

    What does all this Wall Street bullshit mean for you?

    If you own shares and have no plan to sell, you can sell covered calls far out of the money (essentially no chance that the price of the underlying stock reaches the strike price) and collect premiums on a periodic basis. By way of example, TSLA closed at $718.99 today. At that time, a $900 call with a 5/21 expiry was priced at $935 (9.35 x 100) and has a 10.09% chance of ending up in the money. If TSLA fails to reach $900 by 5/21, the entirety of the $935 premium goes to the seller, for a 1.3% profit in roughly a month (at which time you can repeat the process). If TSLA reaches $900, the seller gains the $935 premium and sells 100 shares of TSLA at $900 for a much larger gain (but loses the shares and may have not wanted to).


    This is a pretty rough justice explanation, but hopefully serves as a good initial exposure for some folks to put your equity to work. Happy to answer any questions and can do a part 2 that covers the role of the "greeks" in options that dictate the price and price fluctuations of options resulting from changes in price of underlying stocks and volatility, etc.

    If you're long Tesla now sell the April 30 $750 call and collect $25. Implied volatility is nearly 80% and will decay rapidly.

    If you get called away @ $750 take your $775 ($750 + $25 premium) and skip away.

    Or you could go exotic, sell the April 30 $750 call collect $25, sell the April 30 put and collect $12 then buy the May 14 $650 put for $23.

    Net, net you collect $14 and you have protection if the stock drops 7% or more. If Tesla goes lower the near term put will decay quicker.

    I wouldn't own Tesla, but if I did, that's how I would protect it and collect some premium.
    I just grabbed something random off of the option chain. Titrating the right call is another beast altogether.
  • creepycougcreepycoug Member Posts: 22,706
    First Anniversary 5 Up Votes 5 Awesomes Photogenic
    This is a good explanation @Sources .

    I wonder how many of our Club members play in the derivatives game?
  • BasemanBaseman Member Posts: 12,365
    First Anniversary First Comment 5 Up Votes Combo Breaker
    edited April 2021
    Baseman said:

    Sources said:

    I think the general sentiment of the board here is to take a long view (shout out to my JACKS) on investments. In view of this, I thought it'd be helpful to cover an easy way to generate income while holding equities long term: covered calls.

    What is a call?

    To understand a covered call, you have to understand what a call option is first. I'm too lazy to come up with a definition, so here is one off of the internet:

    Call options are financial contracts that give the option buyer the right, but not the obligation, to buy a stock, bond, commodity or other asset or instrument at a specified price within a specific time period. The stock, bond, or commodity is called the underlying asset. A call buyer profits when the underlying asset increases in price.

    https://www.investopedia.com/terms/c/calloption.asp

    More specifically, options are a "derivative" because their entire existence and price action is derived from an underlying equity. Each call option gives the holder the right to buy 100 shares of a company at a specific price, known as the strike price, up until a specified date, known as the expiration date. If, for instance, you have a TSLA call option for $800, you can buy TSLA for $800 at any time prior to expiry of the option. If TSLA is less than $800 at expiry, the option expires worthless. If not, the option is executed at the $800 strike price.

    The market price of the call option is the "premium". It is the price paid for the rights the call option provides. If at expiry the underlying asset is below the strike price, the call buyer loses the premium paid.

    Covered Call

    Rather than buying call options, one can sell calls as well. A covered call is the sale of a call option in which the investor selling owns an equivalent amount of the underlying security (100 shares per option contract). This way, if the price of the underlying stock goes above the strike price, the shares are sold to the buyer at the strike price. The seller then receives the premium plus any increase in the stock price up to the premium (if any).

    What does all this Wall Street bullshit mean for you?

    If you own shares and have no plan to sell, you can sell covered calls far out of the money (essentially no chance that the price of the underlying stock reaches the strike price) and collect premiums on a periodic basis. By way of example, TSLA closed at $718.99 today. At that time, a $900 call with a 5/21 expiry was priced at $935 (9.35 x 100) and has a 10.09% chance of ending up in the money. If TSLA fails to reach $900 by 5/21, the entirety of the $935 premium goes to the seller, for a 1.3% profit in roughly a month (at which time you can repeat the process). If TSLA reaches $900, the seller gains the $935 premium and sells 100 shares of TSLA at $900 for a much larger gain (but loses the shares and may have not wanted to).


    This is a pretty rough justice explanation, but hopefully serves as a good initial exposure for some folks to put your equity to work. Happy to answer any questions and can do a part 2 that covers the role of the "greeks" in options that dictate the price and price fluctuations of options resulting from changes in price of underlying stocks and volatility, etc.

    If you're long Tesla now sell the April 30 $750 call and collect $25. Implied volatility is nearly 80% and will decay rapidly.

    If you get called away @ $750 take your $775 ($750 + $25 premium) and skip away.

    Or you could go exotic, sell the April 30 $750 call collect $25, sell the April 30 $650 put and collect $12, then buy the May 14 $650 put for $23.

    Net, net you collect $14 and you have protection if the stock drops 7% or more. If Tesla goes lower the near term put will decay quicker.

    I wouldn't own Tesla, but if I did, that's how I would protect it and collect some premium.
    If anyone put this trade on, you're in good shape. Unless the trend reverses quickly, the $750 calls will expire worthless this Friday as will the April 30 $650 put.

    If the stock doesn't move you could also sell the May 14 put for ~$12 and you end up +$26. Not bad for 10 days, then you can put a new trade on.
  • BasemanBaseman Member Posts: 12,365
    First Anniversary First Comment 5 Up Votes Combo Breaker
    Baseman said:

    Sources said:

    I think the general sentiment of the board here is to take a long view (shout out to my JACKS) on investments. In view of this, I thought it'd be helpful to cover an easy way to generate income while holding equities long term: covered calls.

    What is a call?

    To understand a covered call, you have to understand what a call option is first. I'm too lazy to come up with a definition, so here is one off of the internet:

    Call options are financial contracts that give the option buyer the right, but not the obligation, to buy a stock, bond, commodity or other asset or instrument at a specified price within a specific time period. The stock, bond, or commodity is called the underlying asset. A call buyer profits when the underlying asset increases in price.

    https://www.investopedia.com/terms/c/calloption.asp

    More specifically, options are a "derivative" because their entire existence and price action is derived from an underlying equity. Each call option gives the holder the right to buy 100 shares of a company at a specific price, known as the strike price, up until a specified date, known as the expiration date. If, for instance, you have a TSLA call option for $800, you can buy TSLA for $800 at any time prior to expiry of the option. If TSLA is less than $800 at expiry, the option expires worthless. If not, the option is executed at the $800 strike price.

    The market price of the call option is the "premium". It is the price paid for the rights the call option provides. If at expiry the underlying asset is below the strike price, the call buyer loses the premium paid.

    Covered Call

    Rather than buying call options, one can sell calls as well. A covered call is the sale of a call option in which the investor selling owns an equivalent amount of the underlying security (100 shares per option contract). This way, if the price of the underlying stock goes above the strike price, the shares are sold to the buyer at the strike price. The seller then receives the premium plus any increase in the stock price up to the premium (if any).

    What does all this Wall Street bullshit mean for you?

    If you own shares and have no plan to sell, you can sell covered calls far out of the money (essentially no chance that the price of the underlying stock reaches the strike price) and collect premiums on a periodic basis. By way of example, TSLA closed at $718.99 today. At that time, a $900 call with a 5/21 expiry was priced at $935 (9.35 x 100) and has a 10.09% chance of ending up in the money. If TSLA fails to reach $900 by 5/21, the entirety of the $935 premium goes to the seller, for a 1.3% profit in roughly a month (at which time you can repeat the process). If TSLA reaches $900, the seller gains the $935 premium and sells 100 shares of TSLA at $900 for a much larger gain (but loses the shares and may have not wanted to).


    This is a pretty rough justice explanation, but hopefully serves as a good initial exposure for some folks to put your equity to work. Happy to answer any questions and can do a part 2 that covers the role of the "greeks" in options that dictate the price and price fluctuations of options resulting from changes in price of underlying stocks and volatility, etc.

    If you're long Tesla now sell the April 30 $750 call and collect $25. Implied volatility is nearly 80% and will decay rapidly.

    If you get called away @ $750 take your $775 ($750 + $25 premium) and skip away.

    Or you could go exotic, sell the April 30 $750 call collect $25, sell the April 30 $650 put and collect $12, then buy the May 14 $650 put for $23.

    Net, net you collect $14 and you have protection if the stock drops 7% or more. If Tesla goes lower the near term put will decay quicker.

    I wouldn't own Tesla, but if I did, that's how I would protect it and collect some premium.
    Hang onto this trade. This may end up +$70. Let the APR 30 call and put expire and look to sell a lower strike put below the $650 next week.
  • Pitchfork51Pitchfork51 Member Posts: 26,538
    First Anniversary First Comment 5 Up Votes Combo Breaker
    Systemic racism at work
  • oregonblitzkriegoregonblitzkrieg Member Posts: 15,288
    First Anniversary 5 Awesomes 5 Up Votes First Comment
    Wait for VIX to go above 25 - 30. Sell puts on marquee names. 6 months to 1 year out, collect fat premium. Price can sink well below the current price at the time of trade execution, and you're golden.

    Sell Volatility with VIX above the same trigger point. Or sell volatility on every green weekly candle. UVXY/VXX $ maker.

    If bearish, set up calendars with low VIX, strikes below current price, on SPY or other indices/names. When volatility rises, the 'tent' will expand. You know what this is referring to if you're familiar with these trades. Price can rise more than 10 - 15 points on SPY, beyond were you executed the bearish trade. When a selloff occurs and volatility spikes, you will in most cases be profitable even if price doesn't return back to the price where you executed the trade.
  • BasemanBaseman Member Posts: 12,365
    First Anniversary First Comment 5 Up Votes Combo Breaker
    Baseman said:

    Sources said:

    I think the general sentiment of the board here is to take a long view (shout out to my JACKS) on investments. In view of this, I thought it'd be helpful to cover an easy way to generate income while holding equities long term: covered calls.

    What is a call?

    To understand a covered call, you have to understand what a call option is first. I'm too lazy to come up with a definition, so here is one off of the internet:

    Call options are financial contracts that give the option buyer the right, but not the obligation, to buy a stock, bond, commodity or other asset or instrument at a specified price within a specific time period. The stock, bond, or commodity is called the underlying asset. A call buyer profits when the underlying asset increases in price.

    https://www.investopedia.com/terms/c/calloption.asp

    More specifically, options are a "derivative" because their entire existence and price action is derived from an underlying equity. Each call option gives the holder the right to buy 100 shares of a company at a specific price, known as the strike price, up until a specified date, known as the expiration date. If, for instance, you have a TSLA call option for $800, you can buy TSLA for $800 at any time prior to expiry of the option. If TSLA is less than $800 at expiry, the option expires worthless. If not, the option is executed at the $800 strike price.

    The market price of the call option is the "premium". It is the price paid for the rights the call option provides. If at expiry the underlying asset is below the strike price, the call buyer loses the premium paid.

    Covered Call

    Rather than buying call options, one can sell calls as well. A covered call is the sale of a call option in which the investor selling owns an equivalent amount of the underlying security (100 shares per option contract). This way, if the price of the underlying stock goes above the strike price, the shares are sold to the buyer at the strike price. The seller then receives the premium plus any increase in the stock price up to the premium (if any).

    What does all this Wall Street bullshit mean for you?

    If you own shares and have no plan to sell, you can sell covered calls far out of the money (essentially no chance that the price of the underlying stock reaches the strike price) and collect premiums on a periodic basis. By way of example, TSLA closed at $718.99 today. At that time, a $900 call with a 5/21 expiry was priced at $935 (9.35 x 100) and has a 10.09% chance of ending up in the money. If TSLA fails to reach $900 by 5/21, the entirety of the $935 premium goes to the seller, for a 1.3% profit in roughly a month (at which time you can repeat the process). If TSLA reaches $900, the seller gains the $935 premium and sells 100 shares of TSLA at $900 for a much larger gain (but loses the shares and may have not wanted to).


    This is a pretty rough justice explanation, but hopefully serves as a good initial exposure for some folks to put your equity to work. Happy to answer any questions and can do a part 2 that covers the role of the "greeks" in options that dictate the price and price fluctuations of options resulting from changes in price of underlying stocks and volatility, etc.

    If you're long Tesla now sell the April 30 $750 call and collect $25. Implied volatility is nearly 80% and will decay rapidly.

    If you get called away @ $750 take your $775 ($750 + $25 premium) and skip away.

    Or you could go exotic, sell the April 30 $750 call collect $25, sell the April 30 $650 put and collect $12, then buy the May 14 $650 put for $23.

    Net, net you collect $14 and you have protection if the stock drops 7% or more. If Tesla goes lower the near term put will decay quicker.

    I wouldn't own Tesla, but if I did, that's how I would protect it and collect some premium.
    Right now this is a +$34 trade if you sell the May 14 $650 put. I would keep it open and sell the May 7 $630 put and collect $5. It will likely expire worthless and you would be $19 with the $650 put still open.

    another way to play this if your bullish on Tesla is to sell the May 7 $630 collect $5 and sell a May 14 $600 put and collect $8 and buy a May 14 $560 put for $3. Net/net you'd collect $10 and if Tesla falls below $600 you'd be assigned 100 shares at $600. Keep in mind if Tesla goes below $600 you'd also pick up $5,000 because the $650 put would end up in the money.

    Either way, it will be interesting
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