CHAPTER 5
Covered Calls
Selling a call option against an existing stock position is known by a few common names: covered call, buy-write, and covered write. Generally speaking, the terms are synonymous with a few subtle differences. We will discuss how you can use covered calls in bullish and neutral markets. Before getting into the various strategies, it's important to understand the rationale behind a covered call.
Using covered calls can be a viable strategy in bull and range-bound markets. Covered calls are not advisable in bear markets for two reasons. First, the premiums on call options are reduced during bearish trends, generating lower rates of return and increasing risk. Second, the owner of the actual shares will always have a higher delta than the owner of the call, even with deep in-the-money options. That means the gains in the short position (calls) will never equal the losses of the long position (shares).
One of the most common mistakes of the covered call trader is to ignore a falling stock, believing she can eventually recoup the loss in share value by selling another covered call down the road. Utilizing conditional orders to automate your exit will help keep you disciplined and close out the position when the price behavior warrants.
Another common mistake of a bullish covered call seller is the unwillingness to be assigned. This mistake is made when you buy back the call option at a substantially higher price than it was sold for in an attempt to retain the ...
