Sell a Call Option with More Time Value, from selling the call options. The May 25 call has $1.20 ($120) in time premium (bid price premium) value. 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. Option 2. before even considering using any 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. because when an in the money covered call is exercised, the option seller. Understanding the Strategy May Be More Straightforward by Using an Example: Step … Read my related post Does Living Off Covered Calls Really Work? Based on your overall wealth plan, you may find that you want income more than capital gains. Hire a financial professional if you think you need one. You’re betting for a specific outcome with odds of winning a mere 25% to 40%! Also, the potential rate of return is higher than it might appear at first blush. There is a trade off for this income, however, and more to consider as explained below. since the option strike price is the same as the market price on option expiration. RMBS closed that day at 38.60, and there were 27 days left in the May options cycle (calendar days to expiration). For a more comprehensive breakdown on the different strategies Click Here To Read… Selling Options To Boost Your Income . 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. Selling call options below a stock’s cost can result in selling the underlying stocks at a loss. Sometimes you can even find a deep in the … Also remember that bear markets have, in hindsight, usually been excellent opportunities for covered call strategies once a sideways or bull market resumes. Additionally, many investors sell covered calls in IRA’s to eliminate, defer or reduce taxes. When this happens, unfortunately, all your covered call capital gets tied up in those covered call stocks that didn’t get exercised! . This strategy is commonly used when the call writer expects the stock price … 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. Assume Retire Corp closed at $19.00, or out of the money. 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 … she is okay with that since she did the math, for all 3 possible option expiration outcomes, can be a great income generator for stock investors. Read on to find out how this strategy works. set to significantly lower stock risk when selling covered calls. As you can see, all the profit from this covered call investment came from the sale of the option premium, as is often the case with in the money covered call strategies. for more on covered call risk. This exact discovery led us to create diversified multiple income streams over the past 15 years from real estate, stocks, and online business. than out of the money covered call strategies. In this example, I multiplied the option equation above by 100 because 1 option contract equals 100 shares of stock. ♣  It’s super important to remember that when you sell in the money covered calls, you know that you may have to sell the stock at a loss. Sell a deep in-the-money strike with a 2% time value premium and downside protection of that profit; … There is, You’ll want to decide if you prefer that your covered calls get exercised or not. The worse thing for covered call writing is, bear markets so let’s see how bear markets affect in the money covered call strategies when compared to other covered call strategies. This would be offset by a loss on the stock of $300 ($.50 per share assuming she sold it at $18 on Monday morning following option expiration) leaving her with a, The option buyer could simply buy the stock for less than the strike pri. Figure 2 - RMBS May 25 in-the-money call write profit/loss. Alex can simply sell the stock and close the position. 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. In this case, the option buyer may or may not “exercise” the call option. 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. Keep in mind this is income from one month’s profit from just one covered call position. (To learn more about covered-call strategies, read Covered Call Strategies For A Falling Market.). Sell a Call Option After Stock Rises. 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. Taxes and brokerage commissions are excluded from the calculations in this post. 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. However, in order to compare a monthly or six week return to an annual return, such as dividend income of 3% a year, it helps to calculate covered call returns annualized. ♦Wealth Building Mindset♦ Always evaluate potential best and worst case investment outcomes, then accept and learn from what occurs. The best times to sell covered calls … Read my related post on the cash allocation in a portfolio. For options, both a call and a put option can be in the money. (Find out about another approach to trading covered call. ♦Income Stream Tip♦  The same stocks can be used for covered call strategies repeatedly, sometimes around dividends or earnings news. If the stock drops to $97 by the option expiration date, the option won’t be exercised. And this happens immediately after the call option is sold against the stock. Now back to Alex and her covered call position on Retire Corp. But there is another version of the covered-call write that you may not know about. And, of course, covered calls can be sold on etf’s of other asset classes that often move counter to stocks, such as bonds, or sometimes gold. Click here to get my eBook with our favorite 9 income generating strategies that build wealth, too. 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. The maximum return potential at the strike by expiration is 52.1%. This article is going to cover selling deep in the money (ITM) puts. 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. (Read my related post What Goes Up When Stocks Go Down?). Make Money By Spending Less. 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? This is one reason so much income was generated from this particular covered call; it was a deep in the money covered call strategy. 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. ♦Risk Management Tip♦  All investors will want to confirm that investing in stocks is within their own acceptable risk level before even considering using any covered call strategies. Read my related post Problems with Covered 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. ers living off investments who count on covered calls for income, bear markets can present a real challenge. Trade deep in-the-money calls to increase yield on a stock and lower the downside risk. Remember, the prior month, the stock was at $18.50. 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. Likewise, offset, however, by the reality that managing unexercised covered calls, doesn’t generate as much income as new monthly trades. While it’s not completely under your control whether a call option gets exercised, the covered call strategy used will definitely affect the probability that positions will get called at option expiration. She would be close to breaking even on the overall position if she sold her stock at option expiration. When to Use an In the Money Covered Call Strategy, Less Investment Capital for In the Money Covered Calls, In the Money Covered Call Strategy Pros and Cons. makes more sense to sell in the money covered calls than. 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. Below are the other factors for when to use an in the money covered call strategy, so keep reading. As you may have guessed, selling covered calls is one of them! Click Any Topic Below to Go Straight To It. If so, this loss will offset the income generated from selling the call option as explained more ahead. The option buyer didn’t exercise the option since the market price of the stock on expiration day is below the strike price. 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. ♦Wealth Building Tip♦ All investments are bad if they take an investor outside of acceptable risk while too little risk can hinder investment returns. This is offset, however, by the reality that managing unexercised covered calls doesn’t generate as much income as new monthly trades. This works especially well with in the money covered calls since the overall position cost is lower due to the high option premium. Otherwise, I’d sell an out of the money covered call. Before we begin… Did you know that most traders are always trying to score big… driven by the burning desire to hit it big. The reality is that all covered call strategies are subject to overall stock market risk, as well as stock specific risk. is that stock and option commissions have gotten very cheap over the past two decades due to competition, especially with the ability to buy and sell securities online. Unless Alex buys back the call option, what happens on options expiration depends on the price of the stock on June 15, the third Friday in June that year, so let’s look at that next. Read Trade The Covered Call - Without The Stock.). Looking at another example, a May 30 in-the-money call would yield a higher potential profit than the May 25. Because 90% of traders who buy options without having an edge lose money. 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. 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. 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. That's over three times what highly rated bonds pay. Your email address will not be published. Books about option trading have always presented the popular strategy known as the covered-call write as standard fare. This is why doing the option expiration math for all 3 potential outcomes is important before making any covered call investments. ♦Income Stream Tip♦  Selling call options on high dividend stocks can make sense for investors who always want at least a little income from stocks. Selling deep in-the-money call options represents an innovative approach to obtaining high probability yields. 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). Read my related post How to Create a Wealth Plan that explains this more. The question presented was the following strategy, a “can’t-lose” approach to covered call writing? or out of the money covered call strategy. Based on your overall wealth plan, you may find that you want income more than capital gains. Figure 1 - RMBS May option prices with the May 25 in-the-money call option and downside protection highlighted. 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. Establishing a Deep In The Money Covered Call is extremely simple. Get my free eBook with our top 9 strategies to build wealth while generating income. Even after evaluating the potential outcomes, remember that, while charts and information can be used to guide us, no one can know for certain the stock’s price at option expiration since it’s in the future. excluded from the calculations in this post. However, for retirees and others living off investments who count on covered calls for income, bear markets can present a real challenge. That … This lower basis (adjusted stock price) can also serve as a good place for a stop loss to lower investment risk from stocks. Of course, there is no way to know this with certainty but the stock chart can provide probabilities. The near … 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. Stock Closes at the Strike Price on Options Expiration, 3. Our Income Stream, Wealth Building Adventure Later in Life. Alex bought 600 shares of Retire Corp for $18.50 a share on May 16. Of course, there is no way to know this with certainty but the stock chart can provide probabilities. Selling Deep In The Money Calls Example Let's say you like McMoRan Exploration (MMR, oil & gas company). 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. It’s a quality stock, but based on the stock’s chart, she thinks the stock has a good probability of dropping in value over the short term because it’s at the top of its’ recent trading range. By using Investopedia, you accept our. An in the money covered call strategy involves selling a call option with a strike price lower than the cost of the underlying stock. Now that risk from covered call strategies has been addressed, and how in the money covered calls can be the least risky strategy, lets’ see how an in the money covered call strategy, specifically, works, as opposed to other covered call strategies. Option premiums were higher than normal due to uncertainty surrounding legal issues and a recent earnings announcement. Everyone knows what deep in the money calls means. The deep in-the-money sale often is a form of a buy-write trade. Buying options is a lot like gambling at the casino. They should be considered based on your own situation and commission structure. This occurs with out of the money covered call strategies but not with in the money covered call strategies. Required fields are marked *. 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. The, Higher Income from In the Money Covered Calls. stick with me because it’s important because it makes the math on in the money covered call strategies easy to understand. It’s a fool’s errand. You’re betting for a specific outcome … This is why it’s the strategy at Options … While I’m an AFC, I mostly write based on my 40 year investing adventure; I don’t manage wealth for others although I have hired a few financial advisors over the years. A ratio call write is an options strategy where one owns shares in the underlying stock and writes more call options than the amount of underlying shares. The offers that appear in this table are from partnerships from which Investopedia receives compensation. The stock can fall 38% and still not have a loss, and there is no risk on the upside. Cash collected up front can be … The short call is covered by the long stock (100 shares is the required number of shares when one call is exercised). Before we begin… Did you know that most traders are always trying to score big… driven by the burning desire to hit it big. * ABC Jan 45 calls trading at $18.50 (These are in the money by three strike prices.) Remember, a lower overall stock cost lowers risk. This traditional write has upside profit potential up to the strike price, plus the premium collected by selling the option. What I do, and what you should do, is invest using deep-in-the-money covered calls (DITM). over the past 15 years from real estate, stocks, and online business. Why? And, of course, some stocks do well during bear markets. The six-month (December) deep-in-the-money 1050 call is now trading for $131, meaning you can initiate the long side of the trade for $13,100 instead of $115,500. If you enjoy researching stocks and easily find new ideas for covered calls, you may want all your covered call positions to get exercised so you can enter new positions more often. Here is an example of an in the money covered call strategy. Let’s say that Ali buys 100 shares of stock in Income Streams, Inc, for $100. Therefore, we have a very wide potential profit zone extended to as low as 23.80 ($14.80 below the stock price). 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. DISCLAIMER: Nothing in this post is meant to be taken as personal financial advice. This exact discovery led us to, create diversified multiple income streams. 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. As you can see in Figure 2, with the May 25 in-the-money call write, the potential return on this strategy is +5% (maximum). Let’s look at the third possible outcome at option expiration with her Retire Corp in the money covered call strategy. . This is simply because the strike price is lower with an in the money covered call strategy than it is with an at the money or out of the money covered call strategy. This is calculated based on taking the premium received ($120) and dividing it by the cost basis ($2,380), which yields +5%. Gimmicky strategies of covered call buy-writing are not necessarily the best way to go. 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. Selling in the money covered calls can be an excellent, In the money covered calls, however, tend to be the. For further reading, see Come One, Come All - Covered Calls. 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. Remember, the further away the strike price is above the current stock price, the less income generated since the option premium (price) gets lower as it moves further up and away from the stock price. On the other hand, managing covered calls is probably a little less work than finding new covered calls to sell every month. 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. Instead of selling another call option right after option expiration, 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. Note that this turned out to be a very profitable covered call trade for Alex with a stock that decreased in value. Most investors just assume selling covered calls is risky since it involves options. Because 90% of traders who buy options without having an edge lose money. A fence is a defensive options strategy that an investor deploys to protect an owned holding from a price decline, at the cost of potential profits. 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. The income generated from selling covered calls usually ranges at least two to twenty times that of typical dividend income! 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. Nevertheless, covered call strategies work best and are the easiest to implement in sideways or upwardly trending markets. 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. Put selling by using deep in the money puts is a … Either way, Alex kept the $800 from the option sale. market price when she sold an in the money call option for $1.40 with an $18 strike. An option is said to be "deep in the money" if it is in the money by more than $10. and Stocks That Went Up in 2008 or What Goes Up When Stocks Go Down? that will likely cause the stock to drop, ideally on a temporary basis only. Since in the money covered calls are more likely to get exercised as stocks drop, they are generally a better choice than in the money covered call strategies in declining markets. 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. Traditional Covered-Call Write Let's look at an example using Rambus (RMBS), a company that manufactures and licenses chip interface technologies. And then the game is over. Remember, the higher income trade off with in the money covered call strategies is that the stock can be called at a loss. In other words, if we sold the May 25, we would collect $120 in time premium (our maximum potential profit). Selling call options against shares you already hold brings in guaranteed money right away. That’s not to imply covered call strategies are bad. with our favorite 9 income generating strategies that build wealth, too. income while reducing or eliminating capital gains. Deep In The Money … By writing short-term deep in the money calls on blue-chip stocks, a conservative investor can earn 6% to 9% a year without taking much equity risk. If used with margin to open a position of this type, returns have the potential to be much higher, but of course with additional risk. Why? The deeper in the money the call option is, the greater the probability it will get exercised. Investment capital allocated to covered call selling can get completely tied up with little if any income from stocks during bear markets. Fortunately, there are some advanced covered call management strategies that can be used during stock market downturns. It closed at $17.16. y owning 600 shares of Retire Corp, Alex was able to sell. And, of course, some stocks do well during bear markets. In this case, Alex would have made $800 from selling the call options. Potential Return on in-the-Money Call WritesAs you can see in Figure 2, with the May 25 in-the-money call write, the potential return on this strategy is +5% (maximum). It’s easy for investors to get lured into writing covered calls because the income is so high relative to dividends. (Pardon the irresistible pun.). 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. 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. Likewise, new covered call trades each month tend to generate more income, easier. It’s a fool’s errand. 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. In this scenario, Retire Corp closed at exactly $18, or at the money. Also remember that bear markets have, in hindsight, usually been. She will keep the stock, with the plan to sell another call option soon at an opportune time, anticipating the stock will move back toward the high end of its’ trading range within a week or two based on the stock’s recent trends. The $800 covered call income is from the following calculation: $1.40 per option contract x 6 contracts x 100 = $840. And who doesn’t want higher income for the same amount of capital at risk? Remember that a core principle at Retire Certain is to decide how much time you want to spend on your income streams first, and then implement income generating and wealth building strategies from your lifestyle decision so you can live how you want. These conditions appear occasionally in the option markets, and finding them systematically requires screening. So, by owning 600 shares of Retire Corp, Alex was able to sell the 6 option contracts. The Problem. If increasing stock income by selling covered calls is the primary objective, it’s worth considering in the money covered call strategies. An in the money covered call strategy usually generates higher income while reducing or eliminating capital gains. With this in mind, she decides to sell a call option with a $99 strike for $2 instead of a call option with a $100 strike for $1.50 agsint her Income Streams, Inc. shares. 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. Strategy work think you need one profit than the cost of the money covered call - without the stock )... 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