A while ago, we looked into Options Strategy using Calendar Spreads.  Another common options strategy is Covered Calls.

This piece will provide a brief insight into covered calls and how they can be applied in a real-life situation. In short, executing a covered call strategy involves taking a long position in a desired asset and writing (selling) call options against this asset.

 

The investor can benefit from this by limiting their downside while supplementing their passive income along with dividends as they are able to gain the value of the options premium if left unexercised. The absolute maximum the investor can lose with this strategy is therefore limited to the price paid for the asset minus the premium paid to establish the option positions. Nevertheless, it should be noted that while the downside is limited, there is also a limited upside where investors do not benefit from substantial increases in the underlying asset (see payoff diagram below). Investors cannot capitalize on a bull market for example.

Covered Call

To put this into context with a real-life example, this could involve an investor purchasing 500 Commonwealth Bank (CBA) shares at its current price of ~$86.90. The investor can then choose to write (sell) five $88 strike call options expiring in July 15 (contract size of 100), last trading at $2.51. Here, the maximum loss is equal to the purchase price of the asset minus the value of the option premium received or $84.39 per share. On the flip side, the maximum gain is the strike price of the option ($88) minus the purchase price of the asset ($86.90), plus the option premium ($2.51) on top of this which works out to be $3.61 per share.

This strategy tends to appeal to those that expect the price to rise in the long-term however do not see the same outcome in the short-term and therefore can hedge their downside for the meantime. As the options approach their maturity date, in this case the 15th of July, investors have the option to roll these options on to the next expiry date or simply maintain their long position in order to fully capitalize on rises in the price of the CBA stock.

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Disclaimer:
This article does not take into account the investment objectives, financial situation or needs of a particular person or entity. Before acting on any investment strategy or advice you should first consult with your current ASIC accredited investment professional or seek out a compliant investment professional for such.