Options Strategies: Covered Call Options Strategies: Covered Call Options Strategies: Covered Call

Options Strategies: Covered Call

Option Strategies
Peter Siks

Summary:  Want to make extra returns, even if the stock market moves sideways? You can do this by writing calls on the shares you own.


What is a Covered Call

When writing (selling) a call, you assume an obligation. What duty? A delivery obligation. When you write a call, you assume the obligation to deliver the underlying asset. When writing calls, you have not bought a right, but you have assumed a duty! And the latter is very important for you to realize. When you buy options you have acquired a right, but when you sell options you enter into an obligation.

In the case of writing a call, you enter into a delivery obligation! You commit yourself to potentially having to deliver the shares at the strike price you have written. Your reimbursement for this is the premium received. Because of course you are not going to take on a duty for nothing. If you write the call 25, you may be required to deliver the share for €25. Your compensation for this is the option premium received.

Never write calls without owning the underlying asset! If you write calls without having the underlying asset, the company could theoretically be taken over and that could go up to twice the current price. You are then obliged to deliver the shares at the exercise price.

Why would you want to write calls?

Writing calls on existing shareholdings provides additional returns. You (possibly) sell the shares that you own in the future because you enter into a delivery obligation. This means that if the share rises sharply, you have to deliver the shares, but you had already taken this into account when selling the call. It is of course also possible that you do not have to deliver and at that time you can put the received premium in your pocket.

Example:

Let's take a look at an imaginary ABC stock. The stock is currently trading at €25.33 and you would like to write a call with six months maturity to make some extra return. The call ABC 26 (so you should deliver for €26) yields €0.65. So if you decide to sell this call, you will have to deliver the share to the stock for $26. But because you received $0.65 for this commitment, you are actually selling at $26.65.

What does this mean?

If you were to sell this call, you would therefore enter into a delivery obligation at $26 and you would receive $0.65 for this. This obligation runs until the third Friday of the expiry month.

If the share is below €26 on that third Friday, you can pocket the premium received. Then you can look for the next call to write.

If the stock is above €26, you will be required to deliver the shares for €26. You can be released from this obligation by buying back the call. If you do, you can also decide to immediately sell another call with a higher strike price. This is called roll-over.

When are you happy with this commitment you are taking on?

The optimal scenario is one in which the share rises to $26. You then make a profit on the share as well as on the written call. Because the right to buy at $26 is worth $0 if the share is also listed on the stock exchange at $26 on the third Friday of the expiry month.

When are you not happy?

If the stock is going to rise sharply. In that case, you still have to deliver at $26, while the share on the stock exchange may be worth $31. So you are missing out on profit. And make no mistake, you will not be forgotten and you do have to deliver for $26

If the share goes down very sharply, that is very disadvantageous. It is true that you have received $0.65 for the delivery obligation that you have entered into, but if the share falls by $5, the $0.65 received is only a very limited buffer.

When do you write a call?

If you own the stock and don't really expect a big market movement. You can then make extra return on your share ownership by writing calls. In the most optimal scenario, the share rises to the level just below the level where your obligation lies.

What is your maximum risk?

Your maximum risk occurs with a (very strong) fall. It is true that you have received the option premium, but in the event of a large decline, this offers only limited relief for the loss you incur on your shareholding.

In the worst-case scenario, the company goes bankrupt and your shareholding has become worthless. The only thing you can put in your pocket is the premium received, but of course that is not proportional to the loss you have suffered on the share.

In short

If you own the shares, you can decide to write calls on them. You thus enter into a delivery obligation, but you will receive a premium (money!) for this. This strategy works well in sideways moving markets because then you are taking on an obligation that you are not held to, but you will receive money for it.

 

Quarterly Outlook 2024 Q3

Sandcastle economics

01 / 05

  • Macro: Sandcastle economics

    Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.

    Read article
  • Bonds: What to do until inflation stabilises

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.

    Read article
  • Equities: Are we blowing bubbles again

    Explore key trends and opportunities in European equities and electrification theme as market dynamics echo 2021's rally.

    Read article
  • FX: Risk-on currencies to surge against havens

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperform in Q3 2024.

    Read article
  • Commodities: Energy and grains in focus as metals pause

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities in Q3 2024.

    Read article

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)

Saxo
40 Bank Street, 26th floor
E14 5DA
London
United Kingdom

Contact Saxo

Select region

United Kingdom
United Kingdom

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo is a registered Trading Name of Saxo Capital Markets UK Ltd (‘Saxo’). Saxo is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871. Registered in England & Wales.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.

©   since 1992