uploaded image
Image courtesy of Shutterstock

Making Money with Covered Calls

By:Dr. Jim Schultz

With a covered call you lose less money if the stock price falls, and you can profit if it doesn’t move

  • Moving to options from a portfolio that’s all stocks can certainly be can overwhelming experience.
  • The covered call is a great strategy to use as a bridge from trading nothing but stocks to including some options.
  • Not only does the covered call maintain a bullish bias like long stock, but it also increases your probability of profit to more than you would have with only stock.

Moving from an all-stock portfolio to a mix of stock and options can seem a daunting task. You need to familiarize yourself with a whole new language of options terminology. Plus, the risk-return profiles of options strategies are often far more complex than a simple long stock position. Not to mention that your directional bias in the market is very straightforward with long stock. If the stock rises in price, you make money. If the stock falls in price, you lose money. If the stock goes nowhere in price, you go nowhere with your position. With options, however, your directional bias on a given strategy can be far more dynamic than with just holding stock.

This is where the covered call can be a great bridge connecting stock to options. Not only do you maintain a bullish bias with a covered call as you have with long stock, but you’re also able to tap into the higher probabilities available with short options strategies.

Bullish bias

Arguably one of the biggest advantages of options is that you can easily customize whatever directional bias in the market you want. If you want to be bullish, you can be bullish. If you want to bearish, you can be bearish. If you want to be neutral, you can even be neutral. This flexibility, however, can be overwhelming for a new options trader who doesn’t feel equipped to make those directional decisions just yet.

A covered call, however, maintains the same bullish bias you had with long stock, just to a lesser degree. Long stock is a positive delta position (bullish) and a short call is a negative delta position (bearish), so when you combine long stock with a short call in a covered call, you introduce a bearish component to an otherwise bullish position. 

Specifically, if you have 100 shares of stock, then your delta on that position is +100. But if you add a short call with a -30 delta and create a covered call, then the net result is only +70 delta on the overall position. Therefore, you’re still bullish (something you’re comfortable with coming from an all-stock portfolio), but the degree to which you are bullish is only 70% of what it was with only stock.

Higher probability

Again, with stock, you make money if the stock rises, and you lose money if the stock falls—it’s pretty simple. But with a covered call, you still make money if the stock rises (because you’re still bullish), but you’ll also lose less if the stock falls and actually profit if the stock doesn’t move. 

While stock ownership is always a 50-50 proposition from day to day, by using a short call to create a covered call, you’re able to boost your probability of profit to well over 50% for two reasons. First, you have built in a buffer to the downside, so if the stock price does fall, the short call side of the strategy will benefit. This reduces the overall drawdown on the position’s profitability, and it makes jumping over the hurdle to positive profits much easier. Second, in the event the stock doesn’t move, the extrinsic value on that short call will be slowly decaying over time—turning what would otherwise be a nonevent for a long stock position into a profitable outcome for the Covered Call holder.

Jim Schultz, a quantitative expert and finance Ph.D., has been trading the markets for nearly two decades. He hosts From Theory to Practice, Monday-Friday on tastylive, where he explains theoretical trading concepts and provides a practical application of those concepts to a trading portfolio. @jschultzf3 

For live daily programming, market news and commentary, visit tastylive or the YouTube channels tastylive (for options traders), and tastyliveTrending for stocks, futures, forex & macro.

Trade with a better broker, open a tastytrade account today. tastylive, Inc. and tastytrade, Inc. are separate but affiliated companies.

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Related Posts

tastylive content is created, produced, and provided solely by tastylive, Inc. (“tastylive”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, digital asset, other product, transaction, or investment strategy is suitable for any person. Trading securities, futures products, and digital assets involve risk and may result in a loss greater than the original amount invested. tastylive, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastylive is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparisons, statistics, or other technical data, if applicable, will be supplied upon request. tastylive is not a licensed financial adviser, registered investment adviser, or a registered broker-dealer.  Options, futures, and futures options are not suitable for all investors.  Prior to trading securities, options, futures, or futures options, please read the applicable risk disclosures, including, but not limited to, the Characteristics and Risks of Standardized Options Disclosure and the Futures and Exchange-Traded Options Risk Disclosure found on tastytrade.com/disclosures.

tastytrade, Inc. ("tastytrade”) is a registered broker-dealer and member of FINRA, NFA, and SIPC. tastytrade was previously known as tastyworks, Inc. (“tastyworks”). tastytrade offers self-directed brokerage accounts to its customers. tastytrade does not give financial or trading advice, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastytrade’s systems, services or products. tastytrade is a wholly-owned subsidiary of tastylive, Inc.

tastytrade has entered into a Marketing Agreement with tastylive (“Marketing Agent”) whereby tastytrade pays compensation to Marketing Agent to recommend tastytrade’s brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastytrade. tastytrade and Marketing Agent are separate entities with their own products and services. tastylive is the parent company of tastytrade.

tastycrypto is provided solely by tasty Software Solutions, LLC. tasty Software Solutions, LLC is a separate but affiliate company of tastylive, Inc. Neither tastylive nor any of its affiliates are responsible for the products or services provided by tasty Software Solutions, LLC. Cryptocurrency trading is not suitable for all investors due to the number of risks involved. The value of any cryptocurrency, including digital assets pegged to fiat currency, commodities, or any other asset, may go to zero.

© copyright 2013 - 2024 tastylive, Inc. All Rights Reserved.  Applicable portions of the Terms of Use on tastylive.com apply.  Reproduction, adaptation, distribution, public display, exhibition for profit, or storage in any electronic storage media in whole or in part is prohibited under penalty of law, provided that you may download tastylive’s podcasts as necessary to view for personal use. tastylive was previously known as tastytrade, Inc. tastylive is a trademark/servicemark owned by tastylive, Inc.