Second, if you’re selling out of the money covered calls in down trending markets, those out of the money covered calls are unlikely to get exercised. Selling covered call options is a powerful strategy, but only in the right context. It involves writing (selling) in-the-money covered calls, and it offers traders two major advantages: much greater downside protection and a much larger potential profit range. And this happens immediately after the call option is sold against the stock. ♦Wealth Building Tip♦ All investments are bad if they take an investor outside of acceptable risk while too little risk can hinder investment returns. After a covered call is exercised, the capital used to own the stock is available for new covered call positions. An option is said to be "deep in the money" if it is in the money by more than $10. That may not sound like much, but recall that this is for a period of just 27 days. Based on your overall wealth plan, you may find that you want income more than capital gains. One of the most popular short trading methods is selling out-of-the-money … While the underlying stock price will have drop by the dividend amount, the written call options will also register the same drop since deep-in-the-money options have a delta of nearly 1. This is because the entire position can be entered into based on the optimal income initially. The deeper in the money the call option is, the greater the probability it will get exercised. Again, this means that in the money covered call strategies generate higher income than out of the money covered call strategies. During times of high volatility, for example, I have structured covered calls with a very low risk loss potential of about 1% while using stop losses and selling covered calls against a diversified portfolio of etfs for income. This is because the call option income offsets the cost of the stock the minute the call option income hits your brokerage account. But there is another version of the covered-call write that you may not know about. While there is less potential profit with this approach compared to the example of a traditional out-of-the-money call write given above, an in-the-money call write does offer a near delta neutral, pure time premium collection approach due to the high delta value on the in-the-money call option (very close to 100). Alternatively, you may have an insight into an upcoming event, such as company earnings or a new competitive product, that will likely cause the stock to drop, ideally on a temporary basis only. If the overall market is trending down, however, it usually makes more sense to sell in the money covered calls than out of the money covered calls as explained below, IF you choose to stay invested in stocks despite the decline. brokerage account for the sale of the option, generating strategy for those living off investments, c. 00 covered call income is from the following calculation: How Many Stocks Does One Option Contract Represent? Alex bought 600 shares of Retire Corp for $18.50 a share on May 16. market price when she sold an in the money call option for $1.40 with an $18 strike. Your email address will not be published. They are addicted to the thrill of the game as they continue to look for that next explosive trade. If so, this loss will offset the income generated from selling the call option as explained more ahead. Alternative Covered Call Construction As you can see in Figure 1, we could move into the money for options to sell, if we can find time premium on the deep in-the-money options. One of the practical applications of selling cash-secured puts is to buy shares “at a discount” In my books and DVDs I use out-of-the-money puts in lieu of setting limit orders in order to accomplish this goal. Alex can watch the stock chart with the plan to sell a call option near the top of the current trading range to get a higher option premium. This is why doing the option expiration math for all 3 potential outcomes is important before making any covered call investments. It’s easy for investors to get lured into writing covered calls because the income is so high relative to dividends. And then the game is over. Either way, Alex kept the $800 from the option sale. A collar, commonly known as a hedge wrapper, is an options strategy implemented to protect against large losses, but it also limits large gains. But the good thing is that Alex gets to keep the $ 1.40 for selling the option, which reduces her Retire Corp position cost per share cost to $17.10. price since the option prices have declined with the stock price. While in the money covered call strategies may do best in declining stock markets, out of the money covered calls aren’t ideal either on declining stocks or etf’s. Investment capital allocated to covered call selling can get completely tied up with little if any income from stocks during bear markets. The May 25 call has $1.20 ($120) in time premium (bid price premium) value. An option is said to be "deep in the money" if it is in the money by more than $10. Assume the option buyer did not exercise the option by buying the stock. (Pardon the irresistible pun.). Again, it’s important to first note that investors who own stocks without covered calls, especially stocks that don’t pay dividends, also suffer during bear markets. And, of course, some stocks do well during bear markets. Traditional Covered-Call Write Let's look at an example using Rambus (RMBS), a company that manufactures and licenses chip interface technologies. Note that this turned out to be a very profitable covered call trade for Alex with a stock that decreased in value. That's over three times what highly rated bonds pay. It’s a fool’s errand. This exact discovery led us to, create diversified multiple income streams. Books about option trading have always presented the popular strategy known as the covered-call write as standard fare. In this next possible outcome, assume Retire Corp closes below $18, or deep in the money. This is not common but stick with me because it’s important because it makes the math on in the money covered call strategies easy to understand. For further reading, see Come One, Come All - Covered Calls. Plus, … Before we begin… Did you know that most traders are always trying to score big… driven by the burning desire to hit it big. I like to assess this from a stock chart, as well as fundamentals such as earnings and dividends, while also factoring in the risk I am willing to accept. Read my related post Does Living Off Covered Calls Really Work? Does Living Off Covered Calls Really Work? The worse thing for covered call writing is experiencing bear markets so let’s see how bear markets affect in the money covered call strategies when compared to other covered call strategies. Alex can simply sell the stock and close the position. On the other hand, managing covered calls is probably a little less work than finding new covered calls to sell every month. Understanding the Strategy May Be More Straightforward by Using an Example: Step … My experience has been that usually the very first covered call on a new position has the best return over ongoing, managed positions, giving me a bias toward at the money or in the money covered calls. Let’s look at the third possible outcome at option expiration with her Retire Corp in the money covered call strategy. Like Ali, you may have checked a stock chart and seen that the stock is at the high end of the recent trading range. This strategy is commonly used when the call writer expects the stock price to decrease, or to increase the probability of the option being exercised. When this happens, unfortunately, all your covered call capital gets tied up in those covered call stocks that didn’t get exercised! Click here to get my eBook with our favorite 9 income generating strategies that build wealth, too. One of 3 things could happen at option expiration as outlined below. The best times to sell covered calls … Proposed strategy. Let’s say that Ali buys 100 shares of stock in Income Streams, Inc, for $100. A call option is an agreement that gives the option buyer the right to buy the underlying asset at a specified price within a specific time period. (To learn more about covered-call strategies, read Covered Call Strategies For A Falling Market.). And after investing in stocks for almost 40 years, I’ve learned the importance of addressing risk management before even considering any investment, so let’s do that first. ♦In My Experience♦ I usually enter in the money covered call strategies, however, with the expectation that the stock will temporarily decrease in value. Therefore, we have a very wide potential profit zone extended to as low as 23.80 ($14.80 below the stock price). stick with me because it’s important because it makes the math on in the money covered call strategies easy to understand. Get my free eBook with our top 9 strategies to build wealth while generating income. In other words, if we sold the May 25, we would collect $120 in time premium (our maximum potential profit). An in the money covered call strategy involves selling a call option with a strike price lower than the cost of the underlying stock. This lower basis (adjusted stock price) can also serve as a good place for a stop loss to lower investment risk from stocks. The formula for calculating maximum profit is given below: ers living off investments who count on covered calls for income, bear markets can present a real challenge. Some of our members have inquired about using deep in-the-money puts (strike well above current market value) instead of out-of-the-money … Otherwise, I’d sell an out of the money covered call. This works especially well with in the money covered calls since the overall position cost is lower due to the high option premium. They are addicted to the thrill of the game as they continue to look for that next explosive trade. Alex can sell a call option for two or more months out, increasing the option premium by increasing the time value. Most investors just assume selling covered calls is risky since it involves options. How Does an In the Money Covered Call Strategy Work? set to significantly lower stock risk when selling covered calls. The stock can fall 38% and still not have a loss, and there is no risk on the upside. It’s easy for investors to get lured into writing covered calls because the income is so high relative to dividends. In this example, I multiplied the option equation above by 100 because 1 option contract equals 100 shares of stock. Again, it’s important to first note that investors who own stocks without covered calls, especially stocks that don’t pay dividends, also suffer during bear markets. Figure 1 - RMBS May option prices with the May 25 in-the-money call option and downside protection highlighted. And who doesn’t want higher income for the same amount of capital at risk? In this case, Alex would have made $800 from selling the call options. Before we begin… Did you know that most traders are always trying to score big… driven by the burning desire to hit it big. and Stocks That Went Up in 2008 or What Goes Up When Stocks Go Down? This post goes into more detail ahead, outlining the income, three different outcomes, and potential actions at option expiration for a specific in the money covered call strategy so keep reading. Also remember that bear markets have, in hindsight, usually been. This strategy is commonly used when the call writer expects the stock price … before even considering using any covered call strategies. Now back to Alex and her covered call position on Retire Corp. That’s not to imply covered call strategies are bad. Contrary to popular belief, selling covered calls slightly reduces stock risk over owning stocks outright without a covered call strategy sold against them. Ali’s example gives you a basic and broad idea of why a covered call seller may choose an in the money covered call strategy. Cash collected up front can be … This was the market price when she sold an in the money call option for $1.40 with an $18 strike. Of course, there is no way to know this with certainty but the stock chart can provide probabilities. * ABC Jan 45 calls trading at $18.50 (These are in the money by three strike prices.) Because 90% of traders who buy options without having an edge lose money. And these higher premiums lower the biggest risk of using covered call strategies: risk of the underlying stock dropping due to either the overall market or stock specific bad news. The deep in-the-money sale often is a form of a buy-write trade. As you saw in the example above, an in the money covered call strategy is commonly used when: Below are several important factors to consider, however, before using an in the money covered call strategy. Nevertheless, covered call strategies work best and are the easiest to implement in sideways or upwardly trending markets. On the other hand, if you struggle to find new covered call positions, out of the money call options may be more convenient since they’re less likely to be exercised than in the money covered calls. Looking at the May 25 strike, which is in-the-money by $13.60 (intrinsic value), we see that there is some decent time premium available for selling. She wanted to generate some income from the stock, so she sold 6 June call options with an $18 strike price for $1.40 each. of $18 so there would have been no reason to exercise the option. It’s a fool’s errand. The near … So, by owning 600 shares of Retire Corp, Alex was able to sell the 6 option contracts. for more on covered call risk. An in the money covered call strategy usually generates higher income while reducing or eliminating capital gains. Here is an example of an in the money covered call strategy. If we were going to do a traditional covered-call write on RMBS, we would buy 100 shares of the stock and pay $3,860, and then sell an at-the-money or out-of-the-money call option. At the time these prices were taken, RMBS was one of the best available stocks to write calls against, based on a screen for covered calls done after the close of trading. When found, an in-the-money covered-call write provides an excellent, delta neutral, time premium collection approach - one that offers greater downside protection and, therefore, wider potential profit zone, than the traditional at- or out-of-the-money covered writes. As you may have guessed, not all in the money covered calls investments are profitable, but many are, and they can be an excellent income source. with our favorite 9 income generating strategies that build wealth, too. This exact discovery led us to create diversified multiple income streams over the past 15 years from real estate, stocks, and online business. We can begin by looking at the prices of May call options for RMBS, which were taken after the close of trading on April 21, 2006. Selling call options against shares you already hold brings in guaranteed money right away. They should be considered based on your own situation and commission structure. aving all your covered calls exercised each month provides capital for fresh positions, without having to allocate more capital to stocks designated for covered calls. In this case, the option buyer may or may not “exercise” the call option. But there is very little downside protection, and a strategy constructed this way really operates more like a long stock position than a premium collection strategy. Everyone knows what deep in the money calls means. In this case, Alex would have made $560 on the overall position as follows: Net Profit per Share                   $.90, Number of Shares                       600, Total Profit                           $560. It makes more sense—instead of buying 500 shares of ABC stock at $60 (for $30,000)—to buy five of the ABC Jan 45 calls … The option buyer could simply buy the stock for less than the strike price of $18 so there would have been no reason to exercise the option. The strategy I implement with my deep in-the-money calls is to buy with a strike date four to seven months in the future in order to provide leverage and downside protection over a long period … Click Any Topic Below to Go Straight To It. If you’re interested in creating diversified income streams and investing strategies other than passive stock and bond portfolios, you’re in the right place; this site is about our (mine and hubby’s) journey to financial independence following our late midlife epiphany that we needed to make some shifts in the way we were investing if we wanted funds for life. first covered call on a new position has the best return, over ongoing, managed positions, giving me a bias toward at the money or in the money covered calls. In this case, the option buyer may or may not “exercise” the call option (buy the shares of Retire Corp) since the option strike price is the same as the market price on option expiration. Remember, the higher income trade off with in the money covered call strategies is that the stock can be called at a loss. Stock is trading at 16.91 with $1 increment strikes so any option with a strike of 15 or less … This is offset, however, by the reality that managing unexercised covered calls doesn’t generate as much income as new monthly trades. If you think a stock is headed down, as was the case in the example above with Ali’s stock, selling an in the money call option can be the best strategy. (Read my related post What Goes Up When Stocks Go Down?). are profitable, but many are, and they can be an excellent income source. If you write/sell deep in-the-money calls on stocks you have owned for more than one year, a long-term gain turns into a higher taxed short-term gain. In this case, an in the money covered call strategy may work the best as you’ll see in the example later. Stock Closes Out of the Money on Option Expiration, Lowering Stock Risk with In the Money Covered Calls, The stock price is expected to decrease near term, The call seller wants the option to be exercised. If you hate managing covered calls, in the money strategies may be best for you since more in the money covered call positions get exercised than at the money or out of the money covered call strategies. y owning 600 shares of Retire Corp, Alex was able to sell. The income generated from selling covered calls usually ranges at least two to twenty times that of typical dividend income! Selling in the money covered calls can be an excellent income generating strategy for those living off investments. Note that many covered call writers prefer to open new positions every 4 to 6 weeks for minimal effort with good income, but there are many other covered call time frames, including weekly options. On that strike, there is $260 in time premium available. Alex can sell another call option for the next month against her shares in Retire Corp. Read on to find out how this strategy works. There is, You’ll want to decide if you prefer that your covered calls get exercised or not. This occurs with out of the money covered call strategies but not with in the money covered call strategies. the money covered calls as explained below, Out of the Money Vs In the Money Covered Calls in Bear Markets, income generated since the option premium (price) gets lower as it moves further up and away from the stock price, Second, if you’re selling out of the money covered calls, ince the market is declining, it is harder to sell call options near your stock. since the option strike price is the same as the market price on option expiration. income while reducing or eliminating capital gains. As the striking price is lower than the price paid for the underlying stock, any upward price movement will not benefit the call writer since he has agreed to sell the shares to the option holder at the lower striking price. Make Money By Spending Less. Also remember that bear markets have, in hindsight, usually been excellent opportunities for covered call strategies once a sideways or bull market resumes. You can then sell the underlying stock, buy back the short calls … In this case, Alex would have to sell Retire Corp. below the market price of $19.50 but she is okay with that since she did the math for all 3 possible option expiration outcomes before choosing the best covered call strategy given her evaluation. RMBS closed that day at 38.60, and there were 27 days left in the May options cycle (calendar days to expiration). You’re betting for a specific outcome with odds of winning a mere 25% to 40%! Again this is where deep in the money calls as a strategy for bear markets can be a winning strategy. And, of course, some stocks do well during bear markets. Remember, the prior month, the stock was at $18.50. And then the game is over. It was a little bit of a bummer for Alex because the stock had dropped in value since it was bought at $18.50. Establishing a Deep In The Money Covered Call is extremely simple. The question presented was the following strategy, a “can’t-lose” approach to covered call writing? All you have to do is to write ( sell to open) 1 contract of deep in the money call option for every 100 shares you own. Selling deep in-the-money call options represents an innovative approach to obtaining high probability yields. Income from Covered Calls Vs Capital Gains. Of course, there is no way to know this with certainty but the stock chart can provide probabilities. So, "deep in the money" call options would be calls where the strike price is at least … This means if Alex sells another covered call it will probably not be in the money since doing so would generate too much of a stock loss. The maximum return potential at the strike by expiration is 52.1%. . Alex can sell another call option for the next month against her shares in Retire Corp. ince the stock price has dropped from her purchase price of $18.50. Fortunately, there are some advanced covered call management strategies that can be used during stock market downturns. Sell a Call Option with More Time Value, from selling the call options. The deeper in the money the strike price is to the market price of the underlying security, the higher the premium from a covered call strategy. One last advantage for in the money covered call strategies is that having all your covered calls exercised each month provides capital for fresh positions without having to allocate more capital to stocks designated for covered calls. Trade deep in-the-money calls to increase yield on a stock and lower the downside risk. Now a deep in the money option usually has a delta of .60 or above meaning that the option will move $.60 cents for every dollar move in the underlying stock. ♦Income Stream Tip♦  Note that decay of time value is a huge advantage for option sellers vs option buyers that naturally happens with covered call writing. Any upside move produces a profit. excluded from the calculations in this post. This will be the underlying stock against which she sells call options for some extra income. The Bottom LineCovered-call writing has become a very popular strategy among option traders, but an alternative construction of this premium collection strategy exists in the form of an in-the-money covered write, which is possible when you find stocks with high implied volatility in their option prices. This phrase applies to both calls and puts. . This is because the cost basis is much lower due to the collection of $1,480 in option premium with the sale of the May 25 in-the-money call option. The, Higher Income from In the Money Covered Calls. If you can live with less downside risk and you sold the May 30 call instead, the potential return rises to +9.5% (or +131% annualized) - or higher if executed with a margined account. ♦Income Stream Tip♦  The same stocks can be used for covered call strategies repeatedly, sometimes around dividends or earnings news. For options, both a call and a put option can be in the money. Put selling by using deep in the money puts is a … These conditions appear occasionally in the option markets, and finding them systematically requires screening. My Ultimate RISE Wealth Plan is the best place to begin if you’re interested in designing your own unique, slightly alternative plan to live well for life...Be forewarned; it’s not for the faint of heart. 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