These days, it seems like everyone is looking for some extra income. So today, let’s look at a pair of options strategies that can help.
One popular way to generate income in the markets is through a “covered call.”
This involves selling (also called “writing”) call options using shares you own. By selling the call option, you get to bank the option premium.
This strategy is referred to as a “covered” call because you own shares of the underlying asset. So if the call option is exercised, you can hand over the shares without any issues.
And when you use this strategy multiple times, those premiums can really start to add up.
That’s what makes this a powerful income strategy.
But covered calls also offer another useful feature…
Locking in a Higher Sale Price
If you want to sell your shares, selling a call option can lock in an even bigger win.
For example, say your shares are trading at $100. You could write a call option with a $100 strike price.
You might sell that call option and make a $10 premium ($10 x 100 shares per option = $1,000).
Then, assuming the option gets exercised, you’d collect $10,000 for each option exercised ($100 strike price x 100 shares per option).
So you generated a combined $11,000 from the strategy rather than just the $10,000 you would have made from selling your shares outright.
Note that if your option isn’t exercised, then both the $10 premium and your shares remain yours to keep.
Yet this isn’t the only other way to profit with covered calls.
Let’s take a look at how to expand this strategy even further…
A Double Dose of Income
The covered call strategy can be expanded by also selling a put option leg with the same strike price as the call option.
We call this a “covered short straddle.”
By selling a put option, you agree to buy shares at the strike price if that option is exercised.
In this expanded strategy, both options are written at-the-money (ATM). That means the strike price is the same as the current share price.
So let’s again say we own shares that are trading at $100.
And let’s assume we’re neutral about the stock – we don’t think it’s going to go drastically up or down.
So we’re happy to sell our shares above the current market price. We’re also happy to buy additional shares below the current market price.
As we shared above, selling a call option with a $100 strike price earns us a $10 premium (or $1,000).
Then, we could also sell a put option with a $100 strike price for another $10 premium.
We’ve now generated extra income. We’ve received a combined $20 premium (or $2,000) from writing both a call and put option.
If the stock continues to trade sideways (like we expect), then we have a couple of good scenarios in front of us.
This time, if the call option is exercised, we’ve generated $12,000 total ($100 strike price x 100 shares = $10,000 + $2,000 income from selling our options).
On the other hand, if our put option is exercised instead, we have to buy 100 shares at the $100 strike price.
Yet because of the income we earned, our effective entry price for our new shares is $80 ($10,000 minus the $2,000 income = $8,000).
That’s why a covered short straddle can be a great way to finesse your way in and out of a stock rather than just buying or selling it at the current stock price.
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Finding the Right Setups
As with all option strategies, there is some risk.
With the covered short straddle, the main one occurs if the stock does move drastically.
If the share price surges, you still have to sell your shares at the $100 strike price if your call option gets exercised.
And if the stock plummets, you’ll still have to buy shares at the $100 strike price if your put option gets exercised.
Yet with the right setups, both the covered call and covered short straddle strategies can offer incredible ways to generate income.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
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Have you used these kinds of strategies? If not, do you plan to use them in future trades? Let us know at [email protected].