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OptionNotes

Covered Call (Buy Write)

  • Buy the underlying stock, sell a call on this stock. Treat these as a single unit.
  • Use when slightly bullish or neutral on underlying. Do not use if bearish
  • ITM call max profit = premium received. Reduced downside risk.
  • OTM call max profit = premium + stock appreciation up to the strike price. More downside risk but potentially higher return
  • ITM provides reduced downside risk (premium reduces cost basis). OTM offer potential higher return
  • In the money buy write calls make profit as long as stock doesn’t drop below strike. Keep in mind the volatility, downside protection and ROI. Low beta stocks can work great
  • ITM example: Buy XYZ at 50, sell 48 call for 3. Max profit if stock remains above 48. Some profit as long as price stays above 45 (48 - 3)
  • OTM example: Buy XYZ at 50, sell 52 call for 2. Max profit above 52 = 2 premium + 2 stock appreciation

Diversification

  • Can diversify by selling at two different strikes.
  • Combining ITM with OTM can improve return and downside protection
  • Can all diversify across different expiration

Protection from Stock price fall

  • Consider rolling down instead of selling the stock.
  • If the stock price falls, rolling down (buy back original call, sell another call with lower strike) can provide further downside protection
  • Roll down can lead to a loss-lock-in. If there’s a chance stock might rally back up, consider a rolling down only a portion of calls

If the stock price rises

  • Consider rolling up (buy back original call, sell higher strike call
  • It will potentially increase the max profit but it will reduce downside protection
  • The break even point will move up with the new call sale
  • Rolling up to a distant expiry will require less money ( lower increase in break even)
  • It could potentially lead to more loss if the stock falls back down (reduced downside protection )
  • Increases risk

At or near expiration

  • For ITM call, if trading at parity, roll forward (replace with call in future)
  • For OTM call, determine the per day $ premium for current call vs the future call
  • It might be possible to roll up the OTM call in same expiry for more credit. Usually volatile stocks
  • Let the stock be called if:
    • Rolling forward offer minimal return
    • Rolling forward and up significantly reduces downside protection