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Strategy in brief: Sell call option against the underlying stock you hold.
When to use this strategy: you are moderately bullish and sure that the price will not fall.
Comments:
- Sell lower strike options if you are only somewhat convinced the stock will stagnate or rise.
- Sell higher strike options if you are very confident the stock will stagnate or rise.
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Figure: Sell Covered Call Strategy Example
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Profit: limited to the premium received from sale. At expiration, the break-even point is the strike less the premium received. Maximum profit is realized if the stock settles at or above this strike. It is equal to the put option premium you initially received if the put expires worthless.
Loss: increases as the stock falls. At expiration, losses increase by one point for each point stock is below break-even.
Risk: Unlimited.
Reward: Limited.
Collateral: Always required.
Research Findings and Trading Tips:
This strategy is virtually equivalent to “Sell Naked Put”. Covered calls appear to be based on personal psychological preferences as they involve actual stock ownership. Many investors prefer to own a stock; however, selling a covered call may be considered as an additional possibility to enhance return of existing portfolio. Both strategies have nearly equivalent risk/reward parameters.
By using the “Sell Naked Put” strategy instead of "Sell Covered Call" you can earn risk-free interest on the principal capital invested, for example, in government bonds. Naked puts might well be the top choice of option traders because they require smaller investments, thus providing higher returns.
© "Worry-free Option Trading System" & Stock Markets Institute, 2002 | 
