What is a covered call?
A covered call is an options trading strategy where an investor sells a call option on a stock they already own. By selling a call option, the investor agrees to sell their shares at a predetermined price (known as the strike price) within a specific time frame (expiration date). In return for this agreement, the investor receives a premium from the option buyer. This strategy is considered a non-losing strategy because it provides a way to generate income from a stock position without taking on excessive risk. If the stock price does not rise above the strike price before the option expires, the investor keeps the premium and can sell another call option for additional income. If the stock price does rise above the strike price and the investor is called upon to sell their shares, they still make a profit.
Stock selection is a critical aspect of using covered calls as a trading strategy, and the investor should choose stocks that they have confidence in and believe will perform well. Implied volatility is a measure of how much the market expects a stock’s price to fluctuate, and it affects the price of options. When implied volatility is high, options become more expensive, which means you can sell calls at a higher price and collect more premium.
Why Sell Covered Call On Stock?
Selling a covered call is a great way to generate income and provide some protection for your stock holdings. To sell a covered call, you need to own at least 100 shares of a stock, which can be expensive. However, you can still use this strategy on cheaper stocks, which can be a great option for those with smaller portfolios. When you sell a covered call, you are essentially agreeing to sell your shares at a higher price in the future, in exchange for receiving a premium payment upfront. If the stock price stays below the strike price of the call option, you keep the premium and can sell another call option in the future. If the stock price rises above the strike price, you will be obligated to sell your shares at the higher price, but you will still make a profit due to the premium payment you received. Overall, selling covered calls is a safe and effective strategy for generating income and providing some protection for your stock holdings.
A covered call can be a good idea on stocks moving higher because it allows the investor to generate income from the stock while also potentially profiting from its upward price movement. By selling a call option on a stock that is expected to rise in price, the investor can receive premium income upfront, while still owning the stock and benefiting from any price appreciation up to the strike price of the option. If the stock price rises above the strike price, the option buyer may exercise the option, and the investor will be obligated to sell their shares at the strike price. While this limits the potential gains for the investor, they still make a profit as they received the premium when selling the option. You also get the upside until the strike price is reached.
Covered Call Example
Let’s say you own 100 shares of XYZ stock, which is currently trading at $50 per share. You want to generate some additional income from your stock investment, so you decide to sell a covered call.
You sell one call option with a strike price of $55 that expires in one month. The premium you receive for selling the call option is $2 per share, or $200 total.
If the stock price stays below $55 at expiration, the option will expire worthless and you get to keep the premium. You can then sell another covered call for the next month if you choose.
If the stock price rises above $55 and the option is exercised, you are obligated to sell your 100 shares of XYZ stock to the option buyer at the strike price of $55 per share. However, since you already own the shares, you can sell them without having to buy them on the open market.
In this scenario, you would still make a profit of $5 per share ($55 strike price – $50 cost basis), plus the $2 per share premium you received from selling the option. So your total profit would be $700 ($500 from selling the shares and $200 from the premium).
NIO’s market value has been in a downward trend, hitting multi-year lows in 2023. However, the company’s outlook is now looking up due to China’s relaxation of the zero-Covid policy and the country’s highest purchasing managers index in 11 years, indicating a boost in factory activity. Despite NIO’s market worth exceeding $15.4 billion, its P/S ratio is comparatively lower than other EV companies at 2.1x.
NIO experienced a significant uptick in its delivery momentum, with sedan deliveries now at 7,000 units per month, representing about 70% of total deliveries in March. As China’s economy reopens, the stock is expected to soar, as evidenced by the strong support and bounce from the March 17th low.
In February, NIO experienced a significant uptick in its delivery momentum, delivering over 12,000 units, which is a remarkable 98% increase from the previous year. The company’s March deliveries were also impressive, consistently exceeding 10,000 units per month. NIO is currently focused on expanding its sedan production, which now accounts for almost 70% of its production portfolio. Despite its positive performance, NIO’s shares remain undervalued based on revenues, suggesting that the company’s valuation could potentially double over the next 2-3 years, with its stock price exceeding $20 per share.
In March, NIO delivered 10,378 electric vehicles, surpassing the third-place XPeng Inc. (XPEV) by approximately 50%, as XPeng only delivered 7,002 electric vehicles during the same period. The current leader in terms of delivery momentum is Li Auto Inc. (LI), which delivered a remarkable 20,823 electric vehicles last month, twice the monthly delivery volume of NIO and nearly three times that of XPeng. Li Auto owes its success to its best-selling Li One sport utility vehicle, which continues to experience robust sales. Moreover, Li Auto’s production lines are simpler and more streamlined, as the company’s focus is on just one SUV product, allowing it to ramp up production and deliveries faster than its EV competitors in China.
Rolling Covered Calls
Rolling a covered call is an advanced way to adjust your strike price. Advanced covered call strategies can offer traders more flexibility and potential profit opportunities. Rolling covered calls is a technique that allows traders to extend the life of a current call option contract by rolling it over to a new expiration date. This can be useful in situations where the stock price has not moved as expected, and the trader wants to avoid being assigned on their existing contract. The collar strategy involves buying a protective put option and selling a covered call option simultaneously. This provides downside protection and can limit potential gains, but also adds an extra layer of safety to the covered call position. Ratio writing involves selling more call options than the trader owns shares of stock. This can result in increased profits if the stock price rises, but also carries higher risk if the stock price falls. The repair strategy is used to adjust a covered call position that has lost value. It involves buying back the call option at a loss and selling a new call option at a higher strike price, which can help recoup some of the losses and potentially turn the position profitable again. These advanced strategies require more experience and knowledge, but can offer traders more flexibility and potential profit opportunities.