10 February, 2023 seen 25Covered calls are a popular options trading strategy that can help you generate income from your existing stock…
Covered calls probably are my favorite options trading strategy as it involves the least risk (at least in theory)
A covered call refers to a transaction in the financial market in which the investor selling call options owns the equivalent amount of the underlying security. To execute this an investor holding a long position in an asset then writes (sells) call options on that same asset to generate an income stream. The investor's long position in the asset is the "cover" because it means the seller can deliver the shares if the buyer of the call option chooses to exercise. If the investor simultaneously buys a stock and writes call options against that stock position, it is known as a "buy-write" transaction.
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Usually, covered calls are set and forget style, but sometimes there is a need to adjust. So did happen to me recently:
On October 31, 2019, I bought 100 shares of SPCE paying $11.76 per share. I bought these shares for my daughter's portfolio. Just immediately after this purchase I started to sell calls and puts on it.
On November 22, 2019, when the share price was at its lowest at around $7.45 I sold a covered call with expiry on July 17, 2020, with a strike price of $11 and got $0.6 per share credit. Additionally, I kept selling naked puts to generate additional income.
Now in January 2020, the stock started to climb really fast, some days gaining more than 8%. When the price was hovering around $19 per share. I started to explore how to adjust the covered call, as I had a stock gain of +$800, and also had a call option of -$800.
I was not losing any money here, I was breaking even no matter what, but I wanted to benefit somehow from this surging price.
Now, a couple of things come to my mind, the first one was to roll up the strike price, which would mean closing an existing call with an -$800 loss and opening a new one with a higher strike. I didn't like this idea because of the accounting.
I was searching online for some ideas on how to adjust covered calls and found some valuable info, like in this article: How To Adjust Your Covered Calls On The Fly For Maximum Profits
The author outlays 3 approaches on how to adjust covered calls:
- Close the position outright
- Transition to a new strike price
- Add another layer to the position
I highly encourage to you, go check out that article.
Here is what I decided to do: to sell more naked puts, I chose an $18 strike price, the same expiry on July 17, and got a $4.2 credit. The break-even price for this buy is $13.8
Since October 31, 2019, I have collected $654.60 from selling puts and calls on SPCE stock
SPCE Profit/Loss trading options
There are a few scenarios of what could happen after expiry:
- price is above $18 - say $20, my current shares get called away, I keep premiums (to this date +$650)
- price is in the range of $18 and $13.80 - my shares still get called away + I'm obligated to buy more at $18 - I'm still break-even
- price is below $11 - I keep my existing shares + I have to buy 100 more at $18. My biggest loss (but again so far I have already taken $650 from selling options on SPCE)
- if the price continues to climb significantly to let's say $30 per share - close at the profit existing naked put and open a new one.
- if it cools down to some $15 roll down
What are your thoughts on adjusting covered calls? Leave me a comment, readers and I would love to hear. If you haven't yet, subscribe to the covered calls newsletter to follow my options trades almost instantly!