How Successful is the Approach of Writing Covered Calls?

Should one employ the covered call strategy?

There is no guarantee that using covered calls will result in a low-risk options strategy. Given that the writer already owns the underlying stock, the option carries minimal risk. Still, a sharp decline in the share price may result in a large loss. The loss is mitigated a little by the premium income.

The covered call approach carries a dual disadvantage. To begin with, there is the potential for actual financial loss if the stock price falls below the breakeven level. The breakeven point is the difference between the stock’s purchase price and the option premium. Any strategy that involves owning stocks comes with a lot of risk.

The second concern of the covered call strategy is the possibility of missing out on profits from a sharp increase in the stock price.
The covered call writer is liable to sell the stock at the strike price for as long as the covered call is open. Even though the premium provides some profit potential above the strike price, that profit potential is limited. As a result, the covered call writer does not benefit entirely from an increase in the stock price over the strike.

In a covered call strategy, the most you can lose is the price you paid for the asset minus the option premium you received. On the flip side, the maximum profit is limited to the difference between the strike price of the short call option and the price of the stock when it is bought, plus the premium.

How Do You Determine the Best Covered Call Strategy?

The selection of the appropriate company to sell the option on is critical to the success of covered call strategies. After that, decide on an appropriate strike price. A simple covered call strategy is the most effective when the stock price remains below the strike price of a covered call contract.

Before deciding on a strike price and an expiration date for a covered call, traders should look at stock forecasts. You should think about the stock’s current and expected price movement while making a decision to buy or sell. Equally essential is an assessment of its future course.

The Chemours Company (CC) covered call trading history is detailed in the table below. The stock began a steady decline after I bought shares in July 2021 and then sold covered calls on those shares. Poor foresight and decision-making led to this. However, the monthly covered calls were sold as shown in the table below. In the event that the covered call was exercised, and the stock was called away in December 2021, the investor would realize a 5% gain within 6 months. A nearly 7% loss could be expected from the buy-and-hold strategy if the covered calls weren’t used.

Covered call writing in a bear market

Is It Better to Write Covered Calls Once a Month or Once a Week?

Monthly covered call premiums are always greater than weekly covered call premiums due to the time value of money. The monthly covered call premium provides more protection against stock price declines. Weekly covered calls could boost profits and flexibility. They require more effort to keep track of because they only last a week.

Why in-the-money Covered Calls?

Writing in-the-money covered calls on short time frames is popular among investors seeking a reliable source of income. This strategy is widely used because it affords the investor some security against a falling stock price. He also knows how much money he could make by selling the stock if the call option is exercised. 

It’s important to note the profit potential of in-the-money covered calls. In-the-money calls offer more security against a fall in share prices. Nonetheless, the rate of return is lower than that of out-of-the-money calls.

Selling Covered Calls as a Source of Income: Yes, or No?

When selling covered calls, investors can earn anywhere from 1% to 5% (or even more) of their investment capital. Profitability is based on the option’s strike price, the stock market’s volatility, and the option’s expiration date. Bear this in mind, though. A stock’s volatility increases as the options premium for an out-of-the-money call rises. This is due to the fact that selling a call involves a higher degree of risk in exchange for a higher potential reward.

If you plan on using this money as your primary source of income, it needs to be reliable. Stock market investments are not without risk, and profits are not guaranteed. Making a decent living is a realistic goal but getting there isn’t easy.