On the other hand, managing covered calls is probably a little less work than finding new covered calls to sell every month. She wanted to generate some income from the stock, so she sold 6 June call options with an $18 strike price for $1.40 each. Remember that a core principle at Retire Certain is to decide how much time you want to spend on your income streams first, and then implement income generating and wealth building strategies from your lifestyle decision so you can live how you want. This isn’t to say that this same return on investment could be made if this investment were made repeatedly throughout the year. They are addicted to the thrill of the game as they continue to look for that next explosive trade. Note that many covered call writers prefer to open new positions every 4 to 6 weeks for minimal effort with good income, but there are many other covered call time frames, including weekly options. (Find out about another approach to trading covered call. The Problem. But there is another version of the covered-call write that you may not know about. In this example, I multiplied the option equation above by 100 because 1 option contract equals 100 shares of stock. Remember, the prior month, the stock was at $18.50. This traditional write has upside profit potential up to the strike price, plus the premium collected by selling the option. While it’s not completely under your control whether a call option gets exercised, the covered call strategy used will definitely affect the probability that positions will get, If you hate managing covered calls, in the money strategies may be best for you since mo, in the money covered call positions get exercised, than at the money or out of the money covered call strategies, This is simply because the strike price is lower with an in the money covered call strategy than it is with an at. Any upside move produces a profit. You buy the stock and sell covered calls that … Because 90% of traders who buy options without having an edge lose money. 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. Hire a financial professional if you think you need one. If you enjoy researching stocks and easily find new ideas for covered calls, you may want all your covered call positions to get exercised so you can enter new positions more often. Unless Alex buys back the call option, what happens on options expiration depends on the price of the stock on June 15, the third Friday in June that year, so let’s look at that next. The formula for calculating maximum profit is given below: Stock Closes at the Strike Price on Options Expiration, 3. Assume the option buyer did not exercise the option by buying the stock. This will be the underlying stock against which she sells call options for some extra income. This article is going to cover selling deep in the money (ITM) puts. 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. (Read my related post What Goes Up When Stocks Go Down?). Traditional Covered-Call Write Let's look at an example using Rambus (RMBS), a company that manufactures and licenses chip interface technologies. ♦In My Experience♦ I usually enter in the money covered call strategies, however, with the expectation that the stock will temporarily decrease in value. It’s a fool’s errand. Additionally, many investors sell covered calls in IRA’s to eliminate, defer or reduce taxes. Alex can simply sell the stock and close the position. The deeper in the money the strike price is to the market price of the underlying security, the higher the premium from a covered call strategy. And since the market is declining, it is harder to sell call options near your stock purchase price since the option prices have declined with the stock price. Selling in the money covered calls can be an excellent income generating strategy for those living off investments. Of course, there is no way to know this with certainty but the stock chart can provide probabilities. Plus, … Stock Closes Out of the Money on Option Expiration, Lowering Stock Risk with In the Money Covered Calls, The stock price is expected to decrease near term, The call seller wants the option to be exercised. 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 … over the past 15 years from real estate, stocks, and online business. The strategy I implement with my deep in-the-money calls is to buy with a strike date four to seven months in the future in order to provide leverage and downside protection over a long period … While in the money covered call strategies may do best in declining stock markets, out of the money covered calls aren’t ideal either on declining stocks or etf’s. Books about option trading have always presented the popular strategy known as the covered-call write as standard fare. On the other hand, if you struggle to find new covered call positions, out of the money call options may be more convenient since they’re less likely to be exercised than in the money covered calls. Sell a deep in-the-money strike with a 2% time value premium and downside protection of that profit; … Like any tool, it can be tremendously useful in the right hands for the right occasion, but useless or harmful when used incorrectly. This occurs with out of the money covered call strategies but not with in the money covered call strategies. 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. Even after evaluating the potential outcomes, remember that, while charts and information can be used to guide us, no one can know for certain the stock’s price at option expiration since it’s in the future. set to significantly lower stock risk when selling covered calls. Understanding the Strategy May Be More Straightforward by Using an Example: Step … 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. Contrary to popular belief, selling covered calls slightly reduces stock risk over owning stocks outright without a covered call strategy sold against them. The reality is that all covered call strategies are subject to overall stock market risk, as well as stock specific risk. The Bottom LineCovered-call writing has become a very popular strategy among option traders, but an alternative construction of this premium collection strategy exists in the form of an in-the-money covered write, which is possible when you find stocks with high implied volatility in their option prices. In this case, Alex would have made $800 from selling the call options. This was the market price when she sold an in the money call option for $1.40 with an $18 strike. The worse thing for covered call writing is experiencing bear markets so let’s see how bear markets affect in the money covered call strategies when compared to other covered call strategies. ♦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. This post goes into more detail ahead, outlining the income, three different outcomes, and potential actions at option expiration for a specific in the money covered call strategy so keep reading. 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. In this case, Alex would have to sell Retire Corp. below the market price of $19.50 but she is okay with that since she did the math for all 3 possible option expiration outcomes before choosing the best covered call strategy given her evaluation. 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. 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. In this case, Alex would have made $560 on the overall position as follows: Net Profit per Share                   $.90, Number of Shares                       600, Total Profit                           $560. Cash collected up front can be … ♦Wealth Tip♦ Here’s what’s cool: covered call writers get to multiply the option premium by 100 to get the amount of income received before commissions. Trade deep in-the-money calls to increase yield on a stock and lower the downside risk. Since in the money covered calls are more likely to get exercised as stocks drop, they are generally a better choice than in the money covered call strategies in declining markets. Otherwise, I’d sell an out of the money covered call. And, of course, some stocks do well during bear markets. And, of course, some stocks do well during bear markets. This phrase applies to both calls and puts. Remember, a lower overall stock cost lowers risk. For a more comprehensive breakdown on the different strategies Click Here To Read… Selling Options To Boost Your Income . The question presented was the following strategy, a “can’t-lose” approach to covered call writing? RMBS closed that day at 38.60, and there were 27 days left in the May options cycle (calendar days to expiration). brokerage account for the sale of the option, generating strategy for those living off investments, c. 00 covered call income is from the following calculation: How Many Stocks Does One Option Contract Represent? 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. If increasing stock income by selling covered calls is the primary objective, it’s worth considering in the money covered call strategies. 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. . For further reading, see Come One, Come All - Covered Calls. A call option is an agreement that gives the option buyer the right to buy the underlying asset at a specified price within a specific time period. (To learn more about covered-call strategies, read Covered Call Strategies For A Falling Market.). That's over three times what highly rated bonds pay. before even considering using any covered call strategies. An option is said to be "deep in the money" if it is in the money by more than $10. Investopedia uses cookies to provide you with a great user experience. After a covered call is exercised, the capital used to own the stock is available for new covered call positions. Sometimes you can even find a deep in the … Likewise, offset, however, by the reality that managing unexercised covered calls, doesn’t generate as much income as new monthly trades. Selling in the money covered calls can be an excellent, In the money covered calls, however, tend to be the. This is why doing the option expiration math for all 3 potential outcomes is important before making any covered call investments. This is not common but stick with me because it’s important because it makes the math on in the money covered call strategies easy to understand. Does Living Off Covered Calls Really Work? Selling call options below a stock’s cost can result in selling the underlying stocks at a loss. They are addicted to the thrill of the game as they continue to look for that next explosive trade. As you may have guessed, selling covered calls is one of them! Also, the potential rate of return is higher than it might appear at first blush. 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. Proposed strategy. Buying options is a lot like gambling at the casino. As you can see in Figure 1, it would be possible to sell a May 55 call for $2.45 ($245) against 100 shares of stock. Note that many covered call writers prefer to open new positions every 4 to 6 weeks for minimal effort with good income, but there are many other covered call time frames, including weekly options, how much time you want to spend on your income streams, and wealth building strategies from your lifestyle, Like Ali, you may have checked a stock chart and seen that the stock is at the high end of the recent trading range, f you’re new to stock charts, while technical analysis can seem daunting, v. ery basic technical analysis can be an incredibly valuable tool for evaluating the best covered call strategies. For options, both a call and a put option can be in the money. Alternatively, you may have an insight into an upcoming event, such as company earnings or a new competitive product, that will likely cause the stock to drop, ideally on a temporary basis only. ♦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. During times of high volatility, for example, I have structured covered calls with a very low risk loss potential of about 1% while using stop losses and selling covered calls against a diversified portfolio of etfs for income. The deeper in the money the call option is, the greater the probability it will get exercised. 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. You’re betting for a specific outcome … This is one reason so much income was generated from this particular covered call; it was a deep in the money covered call strategy. ♣  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. At this point, Alex has several options you can see below. Instead of selling another call option right after option expiration. Selling deep in the money puts is an exceptional strategy that pays enormous dividends and has distinct advantages over buying stock and waiting for it to rise. The offers that appear in this table are from partnerships from which Investopedia receives compensation. Now that you’ve seen the factors to consider before choosing an in the money covered call strategy specifically, let’s look at the math with an example. All you have to do is to write ( sell to open) 1 contract of deep in the money call option for every 100 shares you own. Note that this turned out to be a very profitable covered call trade for Alex with a stock that decreased in value. Alex can sell another call option for the next month against her shares in Retire Corp. Sell a Call Option After Stock Rises. Then let’s look at how an in the money covered call strategy works and a specific in the money covered call strategy with the three potential profit or loss outcomes based on the underlying stock price at the option the expiration date. There is a trade off for this income, however, and more to consider as explained below. This is calculated based on taking the premium received ($120) and dividing it by the cost basis ($2,380), which yields +5%. Either way, Alex kept the $800 from the option sale. Based on your overall wealth plan, you may find that you want income more than capital gains. This would be offset by a loss on the stock of $300 ($.50 per share assuming she sold it at $18 on Monday morning following option expiration) leaving her with a profit of $500. One of the most popular short trading methods is selling out-of-the-money … Alex bought 600 shares of Retire Corp for $18.50 a share on May 16. because when an in the money covered call is exercised, the option seller. That … While I’m an AFC, I mostly write based on my 40 year investing adventure; I don’t manage wealth for others although I have hired a few financial advisors over the years. 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. 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. Everyone knows what deep in the money calls means. In this case, an in the money covered call strategy may work the best as you’ll see in the example later. So, by owning 600 shares of Retire Corp, Alex was able to sell the 6 option contracts. . ♦Income Stream Tip♦  To understand why covered calls can be an excellent income generating strategy for those living off investments, compare covered call income to typical stock dividend income. Read my related post Does Living Off Covered Calls Really Work? Selling deep in-the-money call options represents an innovative approach to obtaining high probability yields. Read my related post How to Create a Wealth Plan that explains this more. you may have an insight into an upcoming event. 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. for more on covered call risk. Again, this means that in the money covered call strategies generate higher income than out of the money covered call strategies. 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. Figure 2 - RMBS May 25 in-the-money call write profit/loss. An in the money covered call strategy involves selling a call option with a strike price lower than the cost of the underlying stock. Some of our members have inquired about using deep in-the-money puts (strike well above current market value) instead of out-of-the-money … My experience has been that usually the very first covered call on a new position has the best return over ongoing, managed positions, giving me a bias toward at the money or in the money covered calls. Because 90% of traders who buy options without having an edge lose money. If so, this loss will offset the income generated from selling the call option as explained more ahead. An in the money covered call strategy involves selling a call option with a strike price lower than the cost of the underlying stock. The six-month (December) deep-in-the-money 1050 call is now trading for $131, meaning you can initiate the long side of the trade for $13,100 instead of $115,500. 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 is offset, however, by the reality that managing unexercised covered calls doesn’t generate as much income as new monthly trades. By using Investopedia, you accept our. It closed at $17.16. makes more sense to sell in the money covered calls than. In this scenario, Retire Corp closed at exactly $18, or at the money. than out of the money covered call strategies. You’ll want to decide if you prefer that your covered calls get exercised or not. Option 3. 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. My Ultimate RISE Wealth Plan is the best place to begin if you’re interested in designing your own unique, slightly alternative plan to live well for life...Be forewarned; it’s not for the faint of heart. * ABC Jan 45 calls trading at $18.50 (These are in the money by three strike prices.) If you hate managing covered calls, in the money strategies may be best for you since more in the money covered call positions get exercised than at the money or out of the money covered call strategies. And then the game is over. Our Income Stream, Wealth Building Adventure Later in Life. 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. are profitable, but many are, and they can be an excellent income source. Risk is permanently reduced by the amount of premium received. This works especially well with in the money covered calls since the overall position cost is lower due to the high option premium. Downside protection from the sold call offers only 6% of cushion, after which the stock position can experience un-hedged losses from further declines. We can begin by looking at the prices of May call options for RMBS, which were taken after the close of trading on April 21, 2006. After a covered call is exercised, the capital used to own the stock is available for new covered call positions. 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. Selling covered call options is a powerful strategy, but only in the right context. This was the case with our Rambus example. This would be offset by a loss on the stock of $300 ($.50 per share assuming she sold it at $18 on Monday morning following option expiration) leaving her with a, The option buyer could simply buy the stock for less than the strike pri. The deep in-the-money sale often is a form of a buy-write trade. Selling Deep In The Money Calls Example Let's say you like McMoRan Exploration (MMR, oil & gas company). 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. Required fields are marked *. 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. 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. ♦Income Stream Tip♦  Note that decay of time value is a huge advantage for option sellers vs option buyers that naturally happens with covered call writing. Let’s say that Ali buys 100 shares of stock in Income Streams, Inc, for $100. And who doesn’t want higher income for the same amount of capital at risk? Here is an example of an in the money covered call strategy. 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. And these higher premiums lower the biggest risk of using covered call strategies: risk of the underlying stock dropping due to either the overall market or stock specific bad news. 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). The maximum return potential at the strike by expiration is 52.1%. Gimmicky strategies of covered call buy-writing are not necessarily the best way to go. 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. sell covered calls in IRA’s to eliminate, defer or reduce taxes. 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. Click here to get my eBook with our favorite 9 income generating strategies that build wealth, too. And then the game is over. Why? Figure 1 - RMBS May option prices with the May 25 in-the-money call option and downside protection highlighted. Alex could still use any of the four options available from above but the outcome will be less favorable since the stock price dropped more before the option expiration date. * ABC Jan 50 calls trading at $15 (These are in the money by two strike prices.) 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. If we were going to do a traditional covered-call write on RMBS, we would buy 100 shares of the stock and pay $3,860, and then sell an at-the-money or out-of-the-money call option. They should be considered based on your own situation and commission structure. Before we begin… Did you know that most traders are always trying to score big… driven by the burning desire to hit it big. What Happens at Options Expiration for in the Money Covered Calls? since the option strike price is the same as the market price on option expiration. While there is no room to profit from the movement of the stock, it is possible to profit regardless of the direction of the stock, since it is only decay-of-time premium that is the source of potential profit. If we were to annualize this strategy and do in-the-money call writes regularly on stocks screened from the total population of potential covered-call writes, the potential return comes in at +69%. While it’s not completely under your control whether a call option gets exercised, the covered call strategy used will definitely affect the probability that positions will get called at option expiration. the money covered calls as explained below, Out of the Money Vs In the Money Covered Calls in Bear Markets, income generated since the option premium (price) gets lower as it moves further up and away from the stock price, Second, if you’re selling out of the money covered calls, ince the market is declining, it is harder to sell call options near your stock. 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. Like Ali, you may have checked a stock chart and seen that the stock is at the high end of the recent trading range. She would be close to breaking even on the overall position if she sold her stock at option expiration. Ali already made a nice $2 per contract for the call option she sold. 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. An employee stock option (ESO) is a grant to an employee giving the right to buy a certain number of shares in the company's stock for a set price. The $800 covered call income is from the following calculation: $1.40 per option contract x 6 contracts x 100 = $840. Assume Retire Corp closed at $19.00, or out of the money. And this happens immediately after the call option is sold against the stock. Looking at another example, a May 30 in-the-money call would yield a higher potential profit than the May 25. 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