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Covered Call Strategies

Some investors will run this strategy after they’ve already seen nice gains on the stock. Often, they will sell out-of-the-money calls, so if the stock price goes up, they’re willing to part with the stock and take the profit.

Covered calls can also be used to achieve income on the stock above and beyond any dividends. The goal in that case is for the options to expire worthless.

If you buy the stock and sell the calls all at the same time, it’s called a Buy/Write. Some investors use a Buy/Write as a way to lower the cost basis of a stock they’ve just purchased.

Maximum Potential Profit

When the call is first sold, potential profit is limited to the strike price minus the current stock price plus the premium received for selling the call.

Maximum Potential Loss

You receive a premium for selling the option, but most downside risk comes from owning the stock, which may potentially lose its value. However, selling the option does create an opportunity risk. That is, if the stock price skyrockets, the calls might be assigned and you’ll miss out on those gains.

Break-even at Expiration

Current stock price minus the premium received for selling the call.

Ally Invest Margin Requirements

Because you own the stock, no additional margin is required.

As Time Goes By

For this strategy, time decay is your friend. You want the price of the option you sold to approach zero. That means if you choose to close your position prior to expiration, it will be less expensive to buy it back.

Implied Volatility

After the strategy is established, you want implied volatility to decrease. That will decrease the price of the option you sold, so if you choose to close your position prior to expiration it will be less expensive to do so.

Final thought

As a general rule of thumb, you may wish to consider running this strategy approximately 30-45 days from expiration to take advantage of accelerating time decay as expiration approaches. Of course, this depends on the underlying stock and market conditions such as implied volatility.

You may wish to consider selling the call with a premium that represents at least 2% of the current stock price (premium ÷ stock price). But ultimately, it’s up to you what premium will make running this strategy worth your while.

Beware of receiving too much time value. If the premium seems abnormally high, there’s usually a reason for it. Check for news in the marketplace that may affect the price of the stock. Remember, if something seems too good to be true, it usually is.