Covered Call also known as “Buy Write” and “Share Renting” is getting more popular each day as more people know its true potential. This strategy is almost non-directional – means it doesn’t matter where the market goes (up or down or sideways) you still get the money , upfront.
The next sentence will look like those scams : “If you want extra money – monthly, passive income – with very little effort, then this is for you“. But it’s not scam, it’s legal stock-market-related trade for public (means everybody can do it ). If you have stock / share investment, you should have this monthly income already, if you have not – keep reading.
How big is the money? It’s not spectacular, but typically it will be around 2% to 4% monthly [1. the result may vary depends on the market but this is the typical result] – or more than 24% annually (can your saving produce this? maybe not)
Before we continue, we you are really new about ‘option’, please read this quick introduction about option.
This is how it works:
From the Profit Loss Chart above (read this PLC article if you are not familiar with it) you can see the characteristic of this strategy. When we start, we already in profit. Then you will have maximum profit if the price move up a bit, but the profit will not go up beyond your strike price.
For example:
- The price go up above your strike price (above $10.5): say the price go up to $11. Then the buyer of your option will exercise the option (he/she can buy for $10.5 although the price is $11 now – that’s the reason they buy the option at the first place).But because of this, you actually have additional profit (buy $10, sell $10.5 ==> additional 50c x $1000 = $500 for your pocket – that’s why the strike price should be higher than the price when you write the option / out the money call.Then you simply repeat the whole process from the start again for next month option.
- The price go down below $10: the buyer will not exercise the option (why they want to buy at $10.5 when they can buy cheaper i.e: below $10 directly from the market), the option expired worthless and the value of your option is decreasing. Say the price goes to $9 then now the value of yout stock is only $9000.But this loss is only on paper because you don’t need to sell the stock (if you sell the stock then you make the loss a reality), what you do just write another call option for next month.Remember, if you don’t do this strategy and just hold the stock, if the price go won, you will have the exact on paper loss (losing value of the stock). By using this strategy actually because you have pocketed $300 in advance (from the premium), you may considered that that $1000 loss (price go down from $10 to $9) is offset by that premium. So, if you sell the stock (realized your loss) now, without this strategy you loss $1000, but by using this strategy you loss is partially covered and total loss will only be $700. ($1000 – $300) – Again you don’t need to sell as you can just write another call option.
- The price stay around $10 to $10.5: nothing will happen. You have pocketed your premium upfront and you will simply just do it again for the next month.
As you can see on above example, with $10000 you can derived $300 monthly (3%), if you want some more just multiply your capital, i.e: with $100,000 you can expect $3,000 monthly, and so on.
So, there are 3 different ways you have some profit from this strategy:
There are some factor that you need to know before using this strategy:
There are some better execution to improve this strategy:
Covered Call / Buy Write / “Share Renting” |
– Strategy Quick Profile – | |
Direction | Almost Non-directional |
Expecting market to go up or stay around similar price |
Risk | Limited, partial protection |
Price downturn is partially covered by option premium |
Reward | Limited | Typical reward is 2% to 4% monthly |
Leveraged | No | 100% capital is needed to invest, unless margin lending is used |
Maintenance Cost | No | |
Time Frame | Month | Usually monthly |
As usual, if you have question or something to clarify, feel free to ask your question on the comment box below!