Course Name: Options Trading Strategies In Python: Basic, Section No: 4, Unit No: 9, Unit type: Video
Hi,
I understood the rationale and reasons for protective put but really buffled by the covered call as the risk vs the rewards is lopsided, doesn't make any sense to do that.
Do enlightened me why anybody would like to do that in a neutral stand vs risk/reward.
Tks.
br,
Lucas
A covered call is a market-neutral strategy meaning the trader expects a minor increase or decrease in the underlying stock price for the life of the written call option. It is not very useful for very bullish or bearish views. The strategy is created by holding a long position in an underlying asset and selling a call against the underlying asset.
Consider a scenario where you bought 100 shares at $100. You sell a call option on stock A with a strike price of $105. Assume the premium you receive for writing a call option is $3 per share that is $300 for 100 shares.
Suppose the stock price remains at $100 on-call expiry. In such a scenario, you will not earn any return on stock but since the option expires worthless, you will earn $3 per share from the call premium.
If the stock price decreases to $98. The call option expires worthless, and you will earn $3 per share from the call option premium, and the stock will lose $2 per share. But you still in profit of $1 per share. If the stock price decreases to less than $97, then you start losing money.
Therefore, for a covered call to remain profitable, the stock price shouldn't move much.
You can think of different scenarios and can check the payoff of the covered call.
Hope that helps.