Tip 4: Consider buy-writes.
If you’re attracted to covered calls as an ongoing income strategy, you can buy the stock and sell the call option in a single transaction. This is called a buy-write.
Buy-writes offer more than convenience. For one thing, you reduce your market risk by not legging into the strategy. (When you get into a multi-leg option position in more than one transaction, that’s called legging into the trade.) Because a lot can happen between one trade and the next, even if they’re just a few moments apart, legging into a position can pose some additional risks.
That being said, using a multi-leg position can also be tricky. You’ll likely incur two commissions and it may involve complex tax treatment depending on your personal situation. Be sure to check with a tax advisor before trading a buy-write.
Tip 5: Compare static vs. if-called returns.
Covered calls are a way to earn income on your long stock positions above and beyond any dividends the stock may pay. Static and if-called returns help you figure out if selling the call makes sense for your investment strategy.
Static return on a covered call refers to the scenario in which you sell a covered call and the stock doesn’t budge _ allowing you, as the writer, to keep the premium as income. If-called return assumes assignment will occur and you deliver the stock at the strike price.
You should do the math for both of these scenarios before diving into covered call writing. These numbers are important to ensure you’re working towards your investing goals when implementing this strategy, and that you’ll be satisfied with your returns in the event of either outcome.
If you’re a do-it-yourself type, here’s an example of how you can calculate the different returns including commissions and fees. (These numbers assume you are trading a buy-write and use the cost basis of $50 for the stock.)
Example: Calculating Covered Call Returns
- Call sold: March 55 call
- Call premium: $2.50
- Stock price at time of covered call trade: $50
- Number of shares traded: 100
- Number of contracts traded: 1
- Commission for this trade: $10.55 ($4.95 + $4.95 + $0.65)
- Assignment commission – if assigned: $4.9
Covered calls can be a handy strategy to generate income on your holdings above and beyond any dividends. Typically, you’ll write covered calls on stocks toward which you’re long-term bullish, but not expecting large gains in the immediate future. They can be particularly useful on stocks that are stagnant or experiencing a small dips in the short term.
Be careful. As with any other option strategy, covered calls are never a sure thing. You need to understand your risks and enter the trade with a plan for all possible outcomes.