The covered call is one of the most popular options trading strategies with both novice and veteran traders, due to its simplicity and high probability of success. Here are five reasons you should trade covered calls.
New to options trading? Wendy Kirkland explains call and put options here.
1. Earn Weekly or Monthly Income
One of the primary reasons to trade covered calls is to generate consistent income. When you sell a call contract, you’ll instantly receive a cash premium in your account.
What would you do with some extra cash each week? You might reinvest it, save it, or even go out for a fancy dinner.
Once you receive the premium, it’s yours to use as you see fit. That’s one of the best parts about being an option seller. You get cash upfront and let time work in your favor.
Read more about Theta decay here.
2. Hedge Stocks You Already Own
Did you know that you can hedge stocks you already own by selling calls against them? That’s because the covered call strategy is best implemented on stocks you like in the long term. (That’s probably why you own them).
In essence, you’d be trading some of your future profit potential on those shares in exchange for cash on day one. And, each time you earn a premium on your shares, it means you’ll be hurt less if the company suddenly declines in price.
Let me know in the comments: What’s an example of a stock you’re bullish on long-term but might falter in the short-term?
3. Reduce Cost Basis on Shares You Want to Buy
Sometimes we want to purchase some shares in a company but the stock is just too expensive. Wouldn’t it be great if you could get a 10% or 20% discount? That’s exactly what you can do by selling a covered call.
Each time you sell a call option against your shares, it’s essentially like receiving a discount or a refund on your purchase. Over time, you can reduce your cost basis dramatically, which means you’ll become more and more profitable. If you’ve collected enough premium, you can be profitable on shares even if they’re worth less than what you paid for them initially.
4. Take Advantage Of Volatility
Legendary options trader, and friend of TradeWins, Don Fishback once told me that, when volatility is high, it’s a good time to sell options. This is because one component of option pricing is implied volatility. In other words, it’s the likelihood or potential for stuff to happen. This basic principle means that as volatility increases, options contracts become more expensive. Rather than pay extra for possibly overpriced options, you can use volatility to your advantage by selling expensive call options instead.
5. Profit From Market Greed and FOMO
If you own shares in a company when suddenly some catalyst drives the price up, you’ll need to decide how to react. Should you sell your shares for a profit? Should you ignore the short-term fluctuations and simply hold for the long-term gains? With covered calls, you can potentially have your cake and eat it too. When volatility spikes, you can have the opportunity to sell an outrageously expensive call option to someone who thinks the price will continue to increase. If the stock never reaches your strike price, you can keep your shares and the cash for selling the expensive option as well.