Covered Call | OptionsANIMAL

Covered Call

July 20, 2012 / Ken Bailey

Context is often very important.

I recently heard a person I respect say that the covered call is a suckers bet.    Last year I heard another person I respect suggest several covered calls.  I have traded many covered calls with success.  So who is right?  I would say each is right, in their context.

English: Graph of the profits for a covered call
covered call (Photo credit: Wikipedia)

It is true that the covered call limits your upside and provides limited protection.  That was the contention of the person that doesn’t like the covered call.  So if applied blindly, without doing your homework, it is a suckers bet.  Applied properly, it can result in far greater gains than “buy and home work” alone.

The market will have its ups and downs.  Equities will have their ups and downs.  The strength of the covered call is that you can structure it so that you don’t have to be right, just close.  There are times, at least with the equities that I trade, that the probability of an equity staying below a certain level is VERY high.  The market and news can limit an equity’s upside.  Why not make a little money during those times?  How about using that money to buy a little more of that equity that you like so much while it is down?  Or just using the money to pay bills.

I have monthly bills.  I imagine that you do also.  I can’t spend stock or portfolio appreciation but I can spend the money I pocket from an expired short call or the money I make from a successful covered call.

So the value of the covered call is context specific.  Want to pay your monthly bills?  The covered call can help.  Want to pocket some cash while the market pauses?  The covered call is a great way to do that.  Want to let your bullish equity run?  The covered call is not the trade.  What if you are wrong and your equity goes bullish when you have a covered call?  As long as you have structured it properly you will still profit, no one ever went broke making a profit.  Traded properly, a covered call strategy will outperform “buy and hold” over time.  The most important thing is to “get to know” your equity so that you can effectively use the covered call to limit your downside but not limit a bullish run unless you need the money to pay your bills.

Good trading

Ken Bailey
OptionsANIMAL Instructor

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