8 ways to profit with covered calls

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The covered call trade has always been known as an income strategy as you receive premium for selling calls against your stock. This is the most popular

rationale for implementing this type of trading. However, there are many more dimensions that can be coupled with covered call trading to further

enhance the potential for profits. Here is a list of 7 methods to more profits writing covered call trades.

1. Selling the classic covered call against stock you own. You make money with the time decay of the short call. Usually you sell the near

month or next month out so you can continue to compound your money.

2. You can sell out-of-the-money (OTM) calls as your short call. Here you get the call premium and potential for a capital gain as the OTM call

offers some upside profits for the stock price to increase. 3. You can make more money on a short call when volatility collapses’

early in the trade and you close the trade. We have all been in covered call trades when after a few days the call option loses value and you

find yourself in a very profitable trade. You can close this short call to lock in profits.

4. You can trade the short call as the stock price changes. For example, if the stock price decreases, you can close the short option early for a

profit. Then, the call can be written again when the stock prices snaps

back to higher levels. This is similar to channeling stocks by trading the short call against stock price changes.

5. You can roll up or roll out the short calls to a higher strike price or to a later expiration month. This allows you to squeeze extra profits out of

a stock price rise. 6. You can add option legs to a short call to create spread positions such

as a bull or bear call spread. This is good to take profits from a rising covered call trade or a falling stock price.

7. You can add a long protective put to the covered call position as it will increase in value as the stock price decreases. This is usually utilized

as protection against stock declines but can create more income when a stock price declines while you are holding a covered call position.

8. You can use LEAPS as stock replacement then sell a short call against it. This creates leverage for potential returns and puts less capital at

risk.

It is not necessary to use all of these methods when trading covered calls. It

will be advantageous to the income trader to use more than one method to

make money income from selling premiums. In addition, some of these

methods can be used to enhance and/or protect your monthly income.


Adding these methods does require more monitoring or your covered call

positions. The advantage is that it adds more potential for profits compared

to the classic covered call trade. It really comes down to how active you

want to be in your income trading each month.

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Writing Out-Of-The-Money Covered Calls

If you are bullish on a specific stock, then you should consider writing an

out-of-the-money (OTC) covered call. This type of call includes a strike price

that is above the current stock price. You still get a call premium but it is

generally less than an at-the-money call. But you also get the potential of

stock appreciation because of the higher strike price of the call sold. This

creates a situation for potentially two income streams from one trade.

This trading strategy works best when you can confirm the stock being in an

uptrend or if the stock is bouncing off a support level. A support level would

be something like a 50-day moving average or even a Bollinger Band that

has been stretched on the bottom.

The key to this strategy is to be right about the stock price moving higher in

the near future. Due to the OTM call offering fewer premiums than an ATM

and having a low delta, they can be slow to lose value on a stock pullback.

This strategy should be used in special situations or during a slow moving

bull market.

Also, you want to avoid this strategy when he stock has gapped up until the

new price range is confirmed. Stocks that gap up usually pull back before

they stabilize in a new trading range. However, a stock slowing moving up is

a good opportunity for OTM writes.

This strategy works well when you have a down-day in the stock or market.

The stock price decline will usually be temporary down and will bounce back

in a few trading days. You need to be sure the market decline is not a

permanent correction that will be sustained for months.

This is a good strategy for stocks you do not want called away in a flat

market. You can still get an increased profit if the stock price is above the

entry price at expiration. Then, you get an even bigger return if you get

called out at the higher call strike price.


Writing Deep-In-The-Money Covered Calls

The conservative covered call writer is seeking downside protection and

income from premium. This investor places more value on protecting capital and is not concerned about their stock being called away. This covered call

investor will sell calls that are deep-in-the-money (ITM). This is a good strategy when the market uncertainty increases and there is increasing

worry about a market correction.

For example, if Wal-Mart is trading at $53.00 then a deep ITM call will be

sold at the 45 strike price. This call is $8.00 ITM and provides a 15% downside protection. With a stable stock like WMT, it probably will not go

below the 45 strike price during a market pullback. In fact, WMT has not been below $45.00 in the last three years.

The trade-off for selling ITM calls is that the returns will be lower as the

majority of the call premium is intrinsic value. The method to the madness is that these calls offer more downside protection in return to accepting a

lower time value of premium. ITM call writes can be a very successful strategy when used on large-cap stocks during a market pullback.

There are many covered call traders that suggests they made a higher return over a long time period for several reasons:

It is not that difficult to find a 3% return with 30 days remaining on high quality stocks;

The stocks will be assigned at expiration so you are never stuck with a

stock that is down;

ITM calls have a higher delta so they lose value closer to the stock. You can easily roll down your strike price without a loss;

Trading the short call is more profitable due to the high delta. Here trading refers to buying back the call on a price dip and write them

again on the bounce back.

The ITM writer should concentrate on large-cap, high quality stocks as there

is never a reason to trade poor quality stocks regardless of your strategy

with ITM calls. The one item of note is that this strategy is not the best in a

rising bull market unless you have high risk avoidance to a potential trade

loss.

A variation of this trade is to use it when volatility is high such as in the


financial crisis in 2009. The high volatility will increase the amount of

premium and return. You can use this strategy when there is a pending

event such as an earnings release but not as a speculation trade. The key is

to use this strategy with large-cap, high quality stocks.




Writing Covered Calls With High Quality Stocks Using Volatility

This is a great strategy because it uses the highest quality stocks that high a high volatility. I define a high quality stock as a stock rated 5 stars by the

S&P rating agency. As we know, when volatility is high you get more premium from selling calls against your stock. This will increase your return

on investment for covered writes.

Here is how it works:

stock volatility is higher than the market volatility measured by the S&P 500 index (SPY);

stock has high implied volatility to generate good call writing return on investment;

Stock pays an annual dividend whose yield is at least 3% or better.

Then, if not called out, you can rewrite the call month after month until you are called away. This strategy will minimize the amount of time used in

selecting stocks and managing trades. This will also lower the stress involved with covered call trading.

To implement this strategy, you should look for:

A low to medium historical volatility between 20-40% but higher implied volatility which tends to generate more premiums;

A historical volatility of 30-60% with similar implied volatility as you

will hold these stocks for several months - the high HV will provide more premium each month.

Lastly, do not try this strategy on a lower quality stock just to increase your returns - stay with the 5 star stocks.

The use of high quality stocks will lessen the number of potential stocks

because you have preselected a stock list. The high quality stocks are

generally blue-chip stocks that pay a dividend. I am not a fan of buy and

hold investing but this strategy is an effective way to maximize monthly

income from investments.


The high quality stocks or blue-chips tend to move less in price compared to

smaller cap stocks. These high quality stocks tend to outperform during

periods of uncertainty in the markets. This is why we use these stocks in this

strategy as they can weather the market downturns and rise during a bull

market.




Trading Covered Calls by Legging In

This strategy is a variation of the out-of-the-money (OTM) covered call

strategy. When you are anticipation a market upturn such as a bounce up or

your stock is in a prolonged uptrend, this strategy may work for this type of

situation. The legging in strategy is to buy the stock and then wait for the

price to increase before selling OTM calls. The legging in is related to the buy

the stock (one leg) before you sell the calls (second leg) at a later date to

complete the covered call trade.

This strategy can significantly increase your returns when the stock price

moves up rapidly. Then, you have a decision to make about when to sell the

call. Some traders decide that the stock will continue to rise so they do not

sell the call. Others may decide the stock is out of gas to move higher so

they will sell an OTM call for additional income.

As an example, you may purchase a stock at $52.40. The current month

52.50 call strike is selling for $1.00. You can buy the stock at $52.40 and

sell the 52.50 call for $1.00 and get an unassigned return of 2.14%. You

don’t want to lock in your covered call trade for a low return so you wait on

the stock. To leg in to this trade, you would buy the stock and wait until its

price increases to around $54.00. At this time, the 52.50 call strike price is

$2.50. The leg in trader would sell the 52.50 call strike if the stock was out

of momentum and poised for a pullback. This would create an assigned

return of 5.01%. This return is more than double the initial trade with a

downside protection to $52.50.

The leg in trade more than doubles the unassigned return because the

option premium more than doubled (from $1.00 to $2.50) as the stock price

increased. The return percentage doubled while both trades were at the

same strike price (52.50). This could be even better if the trader moves their

call strike price to 55 to let a stock continue to run up to a higher price.

So what is the trade off for the additional return? Legging-in is a little

speculative because it leaves the investor without a premium for a short


time while waiting for the stock price to increase. Additionally, the trader

does not have the downside protection while owning only the stock without

selling the call. Lastly, the investor could be wrong and the stock never

increases in price.

The bottom-line is that the trader must have a solid reason for why the

stock will increase in price in the short-term. The moment this rationale is

proven wrong, the trader must make a decision on how to proceed with the

stock they own.




Covered Calls on Market Down-Days

One strategy to deal with the current market turmoil is called down-day

covered writing. This is based on looking for stocks that are down on a day

that the market is down. This strategy assumes the rubber band reaction of

the stock bouncing back up when the market move up. This gives the writer

the advantage of buying the stock at a cheaper price than on a market up-

day.

On a day with a big pullback, you are trading a lower premium for the

potential capital gain of the bounce back price. For example, a stock is

trading at $45 and the current month 45 call is priced at $2.10 indicating a

cost basis of $42.90 and an assigned return of 4.9%. However, on the

market down-day, the stock drops to $43 and the 45 call price drops to

$0.90. If you enter this trade by buying the stock at $43 and selling the 45

call for $0.90, your cost basis is now $42.10 and your assigned return is now

6.9%. If the stock falls short of $45 at expiration, you keep the $0.90 in

premium and write a new 45 call at the next expiration date.

The key to this strategy is making sure the stock is trading with the market.

Here we will define the market as the S&P 500. Use a chart service such as

bigcharts to create a chart with your stock. Then click the compare bottom

to add the SPX (S&P 500). You should notice that the stock and SPX have a

very similar pattern. If yes, the two are moving in lockstep together and this

is a good candidate for this strategy.

This strategy is not about the technical movement of the charts but about

the potential snap back movement of the stock. This serves as an example


of why covered call traders sell out-of-the-money (OTM) calls to increase

return on investments.




Covered Calls at Expiration

There are many variations of the covered call trade. The classic covered call

is to select the trade, buy the stock and sell the ATM call. In addition, there

are a number of strategies that are variations of the classic call based on

different trading ideas. One variation is expiration writing.

The investor will scan for short-term writes in the last two weeks of the

current option cycle. The trader is looking for stocks with high premium and

high return on funds invested. To get high returns over such a short time

period usually indicates a high implied volatility and increased risk. When IV

is higher than actual volatility, then there is usually a pending event so you

must research these trades very thoroughly.

One safer way to do this is to find a stock with higher volatility due to an

event planned in advance. Examine the stock to see when the event date is

scheduled. If the event will occur after the current expiration date, then you

can trade in the current month calls. The reason for this is that event

volatility may increase premiums across both the current month and the

next month option cycles. This is a cool trick that most covered call writers

had not heard of before.

This is not a risk free trade but it works if you are right about the timing of

the event expiration being after the current month. The key is to actually

confirm the event date and not speculating about when it will occur. Do not

just go by the high volatility in two month alone. If the IV is in line with the

historical volatility, it may be a great covered call write anyway.




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Disclaimer:

This Special Report is published by G3 Marketers LLC, which operates the famed

Get Rich – Stay Rich: Investing For monthly Income brand and getrichinvestments.com website and publishes the get Rich Monthly Income

Newsletter. Neither the author, G3 Marketers LLC, Get Rich Newsletter nor any person associated with them is a broker or investment adviser, nor is any of them a professional securities analyst; and none of them recommends the

purchase, sale or holding of any security. Your use of any information or strategy appearing in this book, in the Get Rich NEWSLETTER or on getrichinvestments.com

is solely at your own risk. We urge you to do all requisite analysis and properly plan each trade prior to

placing any trade and to manage each open trade effectively. Trading stocks and stock options involves risks, and no strategy can eliminate them entirely. Moreover,

poor trading decisions, frequently the result of greed or panic, are responsible for many losses in covered call writing, and only you can prevent them. Neither the author, Get Rich Newsletter, getrichinvestments.com nor any person associated

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© 2011, G3 Marketers LLC. All rights reserved. Unauthorized reproduction is strictly prohibited. Information is based on best available resources. Opinions reflect judgment at the time and are subject to change.