Writing covered calls in Australia can indeed produce consistent monthly income for investors. A covered call is an option trading strategy where investors write “sell” call options against the shares they already own. Usually, a call option consists 100 shares of a particular stock. In exchange for writing call options, investors receive a premium. The premium, however, comes with an obligation; if the buyer exercises the call option, the investor is obligated to deliver the shares to the buyer.
Fortunately, investors already own the underlying stock, so their potential obligation is very much “covered.” Because the obligation of delivering the shares if the buyer exercises the option is covered, this strategy acquires its name “covered call” writing.
Covered call writing in Australia is a fairly conservative strategy. Nevertheless, there are risks associated with it. With proper ASX options advice, however, covered call writing risks can be minimised or averted. Here are three tips on how to use covered calls Australia successfully.
Keep market volatility in mind
Stocks that exhibit medium implied volatility are the most suitable for the covered call strategy. In case implied volatility is low, the premium that investors get will also be probably low. The premiums will be high if the implied volatility is high, but there is a trade-off.
If the implied volatility is high, the probability of the stock to move considerably in either direction is also high. It could mean that investors have a higher chance of taking a loss if the stock drops significantly, or of having their stock called if the price increases. With covered call strategy, it is to be remembered that if the price rises (and exceeds the strike price), the call buyer can exercise the option and demand the stock.
To be safe, investors should consider the stocks with options that exhibit medium implied volatility. Medium volatility should yield enough premium to make the trade worthy. It also eliminates the big risks that are associated with high-volatility stocks.
Plan with what to do if the stock goes down
Investors normally sell a covered call on a stock on which they are bullish in the long-term. It is really helpful to have a plan in place if the stock goes downward. Nobody likes it when stocks plummet–right? Investors have more choices than they think, however. Many investors assume that writing a call lock them in a position until the call expires. This is not true. Investors have the choice to buy the call and remove their obligation to deliver the stock.
If the stock has fallen since the investor sold the call, he or she may be able to buy the call back; that too at a cost lower than the initial sale price. This way, an investor can make a profit on the option position. Doing this buy-back also removes an investor’s obligation to surrender the stock if exercised. Investors also have the option to dump their long position and prevent further losses in case the stock continues to drop.
If investors are really into covered calls writing, they need to consider an excellent strategy called “buy-write” first; with this strategy, they can buy the stock and write the call option, against that stock, in a single transaction. The strategy of buy-write is not limited to convenience only. One thing this buy-write strategy offers is an instant income, in the form of an option premium. Besides, such options often expire worthless; hence, the investors will get to keep the premium, as well as the ownership of the stock. In the bull market, buy-write strategy can underperform, but in flat and bear markets, the strategy is one of the best strategies for investors.
To conclude, covered calls can be an excellent strategy to generate consistent income. Normally, investors write covered calls on stocks, on which they are long-term bullish. Covered calls are useful on stocks that are stagnant in the short-term. Of course, there are some risks associated with covered calls, but with proper covered calls advice, risks can be minimised.