Writing covered calls is an exceptional options trading strategy to generate consistent monthly income. If you focus on short term contracts that are a little out of the money (OTM), the returns on covered calls are excellent. Writing covered calls on a regular basis is indeed one of the best conservative strategies. If you are willing to accept the risk of giving away your shares (in case the buyer exercises the option), then covered calls writing is a lucrative choice.
The covered calls strategy works well only if you stick to some smart rules:
- For covered calls writing, select stocks that have strong fundamentals. One of the biggest problems with writing covered calls on stocks that are volatile is the loss, which arises when the stock price crashes. Because of this, you need to choose stocks of companies you think are safe and stable.
- Carefully set the strike price. In every case, it should be above your net basis. When the covered call option is exercised, you want to ensure you end up with a profit, and not a loss. When writing covered calls, make sure to set the strike price higher than the price that you paid for the underlying security, i.e. the price of the 100 shares. Also, when writing covered calls, understand the “moneyness” of the option. See how it affects the premium as well as the probability of the option being exercised.
- When the buyer exercises the option, just accept it. You should be willing to give away your shares; it is the risk of this strategy. Of course, you can avoid the exercise by closing or rolling out of positions, but before doing so, analyse the outcomes. Sometimes, letting the covered calls get exercised may prove to be advantageous.
- Be mindful of the earnings announcements as well as the ex-dividend dates that will come up before the option expiry. Price reaction because of such events can affect the value of the call. The possibility of buyer exercising the option is more before the ex-dividend date. For that reason, be aware of such events.
Covered calls strategy can certainly be fruitful. A little caution is required, however. If required, take covered calls advice from an expert.
If you are in Australia and need advice on covered calls or want to learn moreabout covered calls Australia and other options trading strategies, then Total Options can help. Covered calls experts in Australia at Total Options have years of experience in trading covered calls. Along with the covered calls advice, Total Options even provides options education, which aims at teaching everything about options trading in Australia.
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