Part 2 – The Covered Call
The Covered Call, also known as a Covered Buy Write or Covered Call Write, is the options trading strategy that most beginners learn about. It is a strategy which seeks to make a monthly income by selling call options against existing stock holdings.
The Covered Call allows you to generate a regular monthly “rental” income on your current stock portfolio, even when the stock prices remain stagnant. The Covered Call can also be used to protect against a moderate short term drop in stock price, to a limited extent. These characteristics make the Covered Call an attractive options trading strategy for all traders who hold long term stock positions.
Use a Covered Call when you wish to hold on to a stock that is trading sideways to slightly higher, while making a monthly income from it. You can also use a Covered Call to protect your equity when the stock goes into a slight correction, but only to a specific price limit. A Covered Call consists simply of writing 1 contract of out of the money call options for every 100 shares of the underlying stock owned.
The Covered Call is ideal for generating a regular monthly “rental” income from your current stock position.
A recent trade that paid handsome dividends was Fosters, which we entered when there was takeover speculation, back in June.
We bought Fosters at $4.55 and wrote the $4.65 Jul11 Calls for $0.22 and closed the position on the 22nd of June 2011 after the takeover bid was announced, for a tidy 7% profit.
Investors who took advantage of our High Yield Covered Call strategy actually made 30% on the same trade. This strategy will be discussed in a later article, or you can call me on 1300 610 024 to talk about it further.
Chart 1: Fosters Covered Call Trade (Took Profits on Takeover Announcement)
Covered Call Profile
You can plan and analyse your trade as shown above, using the Derivative Profiler option in the Market Analyser software.
Trade Note
We could have made a higher return on the trade if we just bought the stock (14% return), but by using the Covered Call strategy we reduced our risk as we were being paid $0.22 or 5% to wait for the bid to come along. At the time we entered the trade Fosters was saying that they had not been approached by any interested party.
The Trade
Options can be used in order to reduce your risk while participating in the profits from a significant move by the underlying stocks. Here we’ve explained the Covered Call strategy which is used to generate monthly “rental” income from your current stock position.
In future articles we will talk about the Covered Call Collar strategy, which is similar to the protective put options strategy in that you also buy put options as protection, and the Stock Repair strategy which is particularly relevant to this market.
Utilise the features in the Market Analyser software to trade plan your options trades for the particular options strategy using your specific trade selection criteria. You will save time and potentially reduce your trading risk.
By Michael Hevern
Head of Research
See Also:
Options Trading for All Types of Market Environments (Part 1): The Protective Put
For Buy and Sell recommendations on ASX listed companies register for a free trial of MDS Financial Research.
MDS Financial Advisory Services offers general advice on trading options to generate consistent steady income on your investment portfolio. Call 1300 610 024 for further information.
Tags: covered buy write, covered call, covered call write, MDS Financial, options trading, Trader Dealer
