A Beginner's Guide to Selling Covered Calls for Profit
Selling covered calls is a popular and relatively conservative option trading strategy. This guide will walk you through the process of selling covered calls, using a real-life example with FRC stock, to help you understand how it works and how you can profit from it.
Step 1: Buy the underlying shares
First, you need to own the underlying stock. In this example, I purchased FRC shares at $3.93 each. Owning the shares allows you to sell covered call options, which is essentially offering someone the right to buy your shares at a specific price by a specific date.
Step 2: Sell covered call options
Next, you'll sell covered call options for your FRC shares. In this example, I'm selling a May 5th
5
call option at a premium of $1.15 per share (which I reduced to $1.00 to make the trade more attractive). This means I'll make money as long as the FRC stock stays below $6.00 by May 5th.
Step 3: Understand the role of Implied Volatility (IV)
The stock's Implied Volatility (IV) plays a crucial role in determining the option's premium. In this case, FRC had a high IV of 600%, which makes selling call options more lucrative due to the higher premiums. However, buying options when IV is high is not recommended.
Step 4: Calculate your effective cost basis
Subtract the premium received from selling the call option ($1.00 per share) from the initial purchase price of the shares ($3.93). In this example, my effective cost basis for the FRC shares becomes $2.93 per share, as long as the stock stays below
5
by May 5th.
Step 5: Assess potential profits
If the stock price reaches
5
by May 5th, I'll still make a profit by selling your shares at the agreed-upon price of
5
, plus the $1.00 premium per share you received for selling the call option. Your effective selling price would be $6.00 per share.
Step 6: Plan for various scenarios
If the stock price stays below
5
by the option's expiration date, I can potentially sell another covered call option with a higher strike price for the following week or a later date. This allows me to continue profiting from selling options while holding onto my shares.
Selling covered calls can be a profitable strategy for generating income and reducing the cost basis of your stock holdings. By understanding the basics of this strategy and carefully considering the role of Implied Volatility, you can increase your chances of success in the options market.
Step 1: Buy the underlying shares
First, you need to own the underlying stock. In this example, I purchased FRC shares at $3.93 each. Owning the shares allows you to sell covered call options, which is essentially offering someone the right to buy your shares at a specific price by a specific date.
Step 2: Sell covered call options
Next, you'll sell covered call options for your FRC shares. In this example, I'm selling a May 5th
5
call option at a premium of $1.15 per share (which I reduced to $1.00 to make the trade more attractive). This means I'll make money as long as the FRC stock stays below $6.00 by May 5th. Step 3: Understand the role of Implied Volatility (IV)
The stock's Implied Volatility (IV) plays a crucial role in determining the option's premium. In this case, FRC had a high IV of 600%, which makes selling call options more lucrative due to the higher premiums. However, buying options when IV is high is not recommended.
Step 4: Calculate your effective cost basis
Subtract the premium received from selling the call option ($1.00 per share) from the initial purchase price of the shares ($3.93). In this example, my effective cost basis for the FRC shares becomes $2.93 per share, as long as the stock stays below
5
by May 5th. Step 5: Assess potential profits
If the stock price reaches
5
by May 5th, I'll still make a profit by selling your shares at the agreed-upon price of
5
, plus the $1.00 premium per share you received for selling the call option. Your effective selling price would be $6.00 per share. Step 6: Plan for various scenarios
If the stock price stays below
5
by the option's expiration date, I can potentially sell another covered call option with a higher strike price for the following week or a later date. This allows me to continue profiting from selling options while holding onto my shares. Selling covered calls can be a profitable strategy for generating income and reducing the cost basis of your stock holdings. By understanding the basics of this strategy and carefully considering the role of Implied Volatility, you can increase your chances of success in the options market.