Quick Points on the Covered Call Strategy

The covered call is one of the most popular options strategies used by the retail options trader. It is also often one of the first option trading strategies a stock trader will try when entering the options arena.

On days when the market is in pullback mode, we tend to see interest in covered calls increase. Traders often opt to re-evaluate existing covered-call positions when the market is headed lower.

A covered call involves owning shares of a stock or ETF and selling one call option for every 100 owned shares. Investors typically sell calls at strike prices they would not mind selling the stock at. Some opt to sell short-term calls (with 35 or fewer days until expiration) in order to collect the most amount of theta; options typically decay the fastest during the last 30 days of their life.

After the market has rallied for a period of time (like it has recently), it's possible that many traders have seen their stocks rally above the strike prices of the sold covered calls. For example, traders who sold the Netflix (NFLX) 190 calls in late November could be strategizing now as to whether they want to unload their NFLX shares or roll out (or exit) their calls. Even though a trader may be okay with delivering the shares at the original sold strike, they may also take any pullback opportunity they can to “massage” their positions.

If the market has a sharp pullback in the morning, it may offer an opportunity for traders to buy to close covered calls at a discounted price, if the trader believes the stock will continue to move higher.

Here is an example. Let's go back to the Netflix example. Let's imagine that on November 19, an investor bought NFLX at $173 and sold the January 190 call for $6.65, collecting some decent premium.

On December 17 – expiration Friday – the call was trading for $7.45 and the stock at $180, down almost 1% on the day. That means the investor has made $7 in the stock but lost 80 cents on the option.  He could have closed the position at expiration for a profit of $6.20 (minus commissions) on the overall trade.

If the trader thought the stock was going to move higher, however, he could have taken advantage of the pullback in the stock to buy back the covered call to close, then wait for the stock to rally back up and maybe choose to short the March 200 call, currently bid at $12.20. A “roll” like this can provide a bit more upside potential in the stock position.

Realize that by doing this, the trader has to time the trade out a bit more. By selling the 200 call, he will have less of a hedge against NFLX stock, as it has a smaller delta than the 190 call.

• Remember that in-the-money calls will likely not be exercised before expiration, unless they are devoid of most of their time value and if there is a dividend that is greater than the amount of time value of the option.  The other time would be if the stock is extremely hard to borrow.
• Basically, it is unlikely that an at-the-money or slightly-in-the money call will be exercised before expiration day.

Hopefully this opens up your mind about the covered call trade. Remember to always keep your “options” open.

Note: This content was previously published by the Options News Network.¹ It has been edited slightly from the original version.  The Options News Network was affiliated with OptionsHouse, LLC, through our mutual parent company, PEAK6 Investments, L.P.

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