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Direction
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Bullish
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Strategy Type
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Income
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Legs
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Long Stock
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Short Call
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Max Reward
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Capped
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Max Risk
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capped - however risk equals share price - call premium, so losses can be significant if a stock falls to zero in value.
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Time Horizon
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Long stock for the long term and sell Calls against it on a month basis
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Risk Profile
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Conservative
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Payoff Diagram
Description
The Covered Call or Buy and Write strategy is an options investment strategy where an investor purchases 1000 underlying shares and simultaneously sells "writes" a call option contract over the top. The strategy is one of the most basic and widely used options investment strategies as it is extremely conservative. In fact the ASX has proven the strategy to be lower risk and higher return than holding a portfolio of shares.
Steps Involved
Long stock for the long term
Sell a call every 4-6 weeks
Rationale
A neutral or slightly bullish market is expected and an income could be made by selling calls repetitively. Investors are able to sell at the money calls if they are neutral on the market for a larger monthly premium, or sell a higher strike call for a smaller monthly premium and larger capital gain potential.
If calls are in the money, (the market rallies over the month) the investor can buy back the calls and re-sell them at a higher price, often for further premium or a breakeven.
Benefits of the Covered Call Strategy
Generate additional returns over a portfolio by writing options and collecting premiums as income.
Suitable for Self Managed Super funds as the strategy is extremely conservative
An effective way to manage the sale of shares as a seller can sell slightly in the money for a huge premium (4%+). This gives the seller a high chance of selling the stock, however if not, a large premium is made regardless.
How does the Covered Call Strategy compare to the market?
XBW - S&P/ASX200 BUY WRITE INDEX
XJOAI - S&P/ASX200 ACCUMULATION INDEX
Chart Sourced from the Australian Stock Exchange website. www.asx.com.au
Strategy Summary
The covered call strategy is a great way for investors to lower risk, and generate additional returns from an existing portfolio. Many investors use the strategy as apart of an income generation strategy. This involves combining the short put strategy as a way of purchasing shares below the market price, with the covered call strategy as a way of selling shares above the market price. By repetitively completing this cycle, investors are able to significantly lower the risk and increase returns from a portfolio of stocks.