Are you ready to sell securities you own or considering doing so?
Adopting the strategy of selling covered calls is like being paid to
commit to selling your securities.
In this article, you’ll learn how investors can use the strategy of selling covered calls instead of selling shares.
Let’s take the example of an investor who, in the next 30 days, wants to sell 100 XYZ shares at $35 while they are trading at $33. According to his analysis, he believes that the potential for an increase above $35 is limited and would like to use the cash generated to buy another stock that has more potential. However, he recently learned, during an introductory options webinar, that selling a call option required the seller to sell the underlying shares if the option holder exercised his right to purchase. In return for this obligation, the seller of the call option receives a premium that he can keep, regardless of whether the call option is exercised or not by the holder.
He will therefore have the following two choices:
Comparison table of results between directly selling shares and selling a covered call option
|Selling without an options strategy
Submitting an order to sell 100 XYZ shares at $35 valid for 30 days
|Selling with an options strategy
Sale for a premium of $1 of an XYZ call option with a strike price of $35 expiring in 30 days
|Price of XYZ in 30 days||Result from the sale of the shares
||Result of the strategy of selling a covered call option
|$38||$200 (or 6%): [($35-$33) × 100]
||$300 (or 9%): [($35-$33 +$1) × 100]
|$35||$200 (or 6%): [($35-$33) × 100]
||$300 (or 9%): [($35-$33 +$1) × 100]
|$33||$0 (or 0%): [($33-$33) × 100]||$100 (or 3%): [($33-$33+$1) × 100]
|$32||-$100 (or -3%): [($32-$33) × 100]||$0 (or 0%): [($32-$33+$1) × 100]
|$30||-$300 (or -9%): [($30-$33) × 100]||-$200 (or -6%): [($30-$33+$1) × 100]|
In any case, as the table above shows, selling the covered call option generates a higher return than simply selling the shares on the Toronto Stock Exchange.
Finally, we can see that, in all declining price scenarios, selling a covered call option reduces the loss by $100. This difference is due to collecting the $100 premium following the sale of the call option.
The strategy of selling covered call options can be used to sell securities if you believe that the upside price potential is limited. By selling a call option contract for every block of 100 shares held, the seller of the option collects a premium that he can keep, regardless of whether the call option holder exercises it or not. In return for this premium, the seller agrees to sell his shares at the agreed upon strike price if the option holder exercises his right to purchase. If the option is not exercised before it expires, the holder of the shares may sell other covered call options if he still wants to.
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