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 HKEX: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 HKEX:5 by May 5th.
Step 5: Assess potential profits If the stock price reaches HKEX:5 by May 5th, I'll still make a profit by selling your shares at the agreed-upon price of HKEX: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 HKEX: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.
This is a good,quick guide. My trading centers around covered calls and cash secured puts for high IV tickers as well. There are a couple of weaknesses to be aware of, though. If the share price of the ticker drops below your effective cost basis, it can take weeks of selling calls to get back to your breakeven point. If IV declines as well, your calls become much less lucrative.
bitdoctor
⋅
@mentalBustard17168 yes you are correct. I risk more on more stable assets and less on super volatile assets like FRC. I saw the high iv and had to take advantage a bit down here. We will see what happens in the coming weeks