Covered Calls are the Trading Cheat Code | How to Trade Covered Calls

Introduction to Covered Calls

In this section, the speaker introduces the concept of covered calls and explains how they work.

What is a Covered Call?

• A poker chip represents a single share of a company.

• Owning 100 shares allows you to sell a call option against them for cash.

• If the call expires out of the money, you keep your premium and shares.

• If the stock price rises and the call expires in-the-money, you lose your shares but keep the premium and make money from selling at a higher price.

Capitalizing on Covered Calls

In this section, the speaker explains how to capitalize on owning covered calls by selling them for cash.

Writing a Call Option

• Selling a call option creates an entirely new contract that obligates you to provide 100 shares if exercised.

• The seller provides those hundred shares if exercised when it's in-the-money.

• Selling an out-of-the-money call generates income that can be used however you want.

Benefits and Risks of Covered Calls

• Selling covered calls reduces cost basis and makes shares cheaper.

• Owning 100 shares while writing calls will incur some losses if stock prices go down.

• Expiring out-of-the-money means keeping premiums while still owning 100 shares.

Building a Covered Call Position

In this section, the speaker walks through building a covered call position using AMD as an example.

Buying Shares as Collateral

• Buying 100 shares serves as collateral for writing calls against them.

Writing Out-of-the-Money Calls

• Writing out-of-the-money calls generates income without having to buy back positions or losing ownership of stocks.

• The credit received from selling these options can be withdrawn or used however one wants.

Possible Outcomes

• If the stock price goes down, the call expires out of the money and you keep your premium and shares.

• If the stock price goes up, the call may expire in-the-money and you lose your shares but keep the premium and make money from selling at a higher price.

Covered Call Strategy

This section discusses the covered call strategy and how it can be used to make a profit.

How Covered Call Works

• A covered call is when an investor sells a call option on a stock they already own.

• If the stock price goes up, the investor keeps the premium from selling the call option but loses out on potential gains from holding onto the stock.

• If the stock price goes down, the investor still keeps the premium and can continue to hold onto their shares.

Example of Covered Call

• An example is given where an investor buys 100 shares at $50 per share and sells a call option with a strike price of $55.

• If the call expires in-the-money, meaning that the stock price is above $55, then the investor has to sell their 100 shares at $55 but still makes a net gain of $500 ($550 - $50).

• If the call expires out-of-the-money, meaning that the stock price is below $55, then the investor gets to keep their shares and also keeps the credit received from selling the call option.

Choosing Strike Price for Covered Calls

This section discusses how investors can choose which strike price to use when selling covered calls.

Factors to Consider When Choosing Strike Price

• Investors should consider how badly they want to keep their shares and how much premium they want to receive when choosing a strike price.

• Selling calls further out-of-the-money will result in smaller premiums but less chance of being assigned.

• Selling calls closer-to-the-money will result in larger premiums but more chance of being assigned.

Exit Strategy Using Covered Calls

• Selling covered calls can also be used as an exit strategy for investors who no longer want to hold onto their shares.

• By selling a call option with a strike price close to the current stock price, investors can receive a larger premium and potentially exit their position if the stock price goes down.

Understanding Call Options

In this section, the speaker explains how to understand call options and what happens when a call option expires.

How Call Options Work

• When a stock price goes up past your strike, you will see that your call is losing money.

• If you see that your call is losing money, don't panic. At expiration, it will get assigned if it's in the money.

• TD Ameritrade's Thinkorswim platform has an on-demand feature which allows users to trade in the past.

• TD Ameritrade also offers free educational content on their website for users who create an account.

Example Trade on Thinkorswim

• The speaker demonstrates how to buy 100 shares of AMD and sell a call against it using Thinkorswim.

• The speaker sells a 13 strike call for roughly $17-$18 with an expiration date of March 16th.

• On March 16th, the day of expiration, the stock price stayed below the strike of the sold call. The position collected almost all of its premium and did not have to give up its shares.

Understanding Covered Calls

In this section, the speaker explains how covered calls work and why they are a good strategy for traders.

How Covered Calls Work

• A covered call is when you own shares of a stock and sell a call option on those shares.

• The call option gives the buyer the right to purchase the shares at a specific price (the strike price) within a certain time frame.

• If the stock price stays below the strike price, the call option will expire worthless and you keep the premium collected from selling it.

• If the stock price goes above the strike price, you may have to sell your shares at that price but still make a profit due to collecting premium from selling the call option.

Benefits of Covered Calls

• Covered calls can generate income for traders by collecting premiums from selling call options.

• They can also provide downside protection by offsetting losses in case of a drop in stock prices.

• Traders can use covered calls to potentially increase their returns on stocks they already own.

Risks of Covered Calls

• If the stock price rises significantly above the strike price, you may miss out on potential profits by having to sell your shares at that lower price.

• If you don't want to sell your shares at all and need to buy back or close out an in-the-money call option, it could result in significant losses.

Conclusion

In this section, the speaker concludes his explanation of covered calls and invites viewers to ask any questions they may have.

Final Thoughts

• Covered calls are an effective strategy for generating income and protecting against downside risk.

• Traders should be aware of potential risks such as missing out on potential profits or incurring significant losses if they need to buy back an in-the-money call option.

Q&A

• The speaker invites viewers to ask any questions they may have about covered calls.