Mention covered calls and many investors think limited upside and big exposure to the downside. But, it’s possible to make more money with covered calls and do it with less risk.
Covered calls investing involves selling a call option against an existing or purchased stock. The inherent nature of covered calls provides less risk than simply owing the stock outright, as a covered call investing position has downside protection and a stock does not. The initial time value and the amount a covered call investing position is in-the-money determine how much downside protection a call option provides. The larger the time value and the more the covered call investing position is in-the-money, the more downside protection provided.
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As for making more money with covered calls, we will examine an actual trade entered by PowerOptionsApplied‘s Titanium TradeFolioTM.
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On 4/27/2009, Titanium entered a covered calls investing position for American Express (AXP). At entry, the price of AXP was $24.89. The call option which was sold was AXPEE (MAY 25) and it was sold for $1.70. The call option was slightly out-of-the-money with a %if unchanged return of 7.3%. If the price of AXP were unchanged at expiration, then the position would return 7.3%. The %return if assigned was 7.8%, this represents the return at expiration if the price of AXP were to be greater than the call option strike price of $25. The downside protection for this covered call was 6.8%, so as long as the price of AXP did not drop more than 6.8% at expiration, the position would return a profit.
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At stock options expiration on 5/15/2009 the price of AXP was $24.23. The call option was out-of-the-money and expired worthless and the initial call option premium of $1.70 was kept as profit. At this point, a long position in AXP would have a negative return of -2.7%, but the covered calls position had a positive 4.5% return.
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| Comparison of Returns on 5/15/2009 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Covered Calls Return for AXP | Long Position for AXP | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 4.5% | -2.7% | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
On 5/18/2009 the AXP stock was still remaining in the account. Since the call option expired worthless and was not exercised a new call option was sold, AXPFE (JUN 25), for $2.10. At stock options expiration on 6/19/2009, the price of AXP was $24.64, so the call option expired worthless and the initial call option premium of $2.10 was retained as profit. At this point, the return for the covered call investing strategy was 15.3%. In comparison, a long position in AXP would have experienced a loss of -1%.
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| Comparison of Returns on 6/19/2009 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Covered Calls Return for AXP | Long Position for AXP | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 15.3% | -1.0% | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
On 6/22/2009, the AXP stock was still remaining in the account. Since the call option expired worthless and was not exercised, a new call option was sold, AXPGA (JUL 24) for $1.15. At stock options expiration on 7/17/2009, the price of AXP was $28.03. Since the call option was in-the-money, the AXP stock was called away.
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The total return for the covered call investing strategy for AXP was 17.5% and the return for a simple long position in AXP would have returned 12.6%.
| Comparison of Returns on 7/17/2009 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Covered Calls Return for AXP | Long Position for AXP | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 17.5% | 12.6% | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
An additional bonus for holding AXP was a $0.18 dividend paid on 6/30/2009. Factoring in the dividend, the returns for the covered calls and simple long position are shown below:
| Comparison of Returns on 7/17/2009 with Dividend |
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| Covered Calls Return for AXP | Long Position for AXP | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 18.3% | 13.3% | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Do covered calls always return more than a long position? The answer is “no”, but covered calls always provided less risk than a long position. The combination of potential for greater returns along with less risk make covered calls much preferred over simple a long position.
For more information about how to identify and research great option trades, visit the PowerOptions website. There you will find the data you need to make quick, clear, and informed decisions. You can trade knowing you have found the best investment. Also, PowerOptions will allow you, with a few quick clicks, to quickly and accurately compare trades. PowerOptions’ premium customer support is second to none in the industry. They can be easily contacted when you need them at their toll-free number to answer customer questions. Call them now toll free at 877-992-7971.
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PowerOptions’ sister company PowerOptionsApplied provides expert stock options trading recommendations. PowerOptionsApplied specializes in covered calls, naked puts and iron condor stock options strategy recommendations. PowerOptionsApplied provides a 30-day risk free trial of its service.
[tags] stock, trade, out-of-the-money, expiration, strike price, downside protection, AXP, American Express Co. [/tags]