Option Strategy : Covered Call

Covered Call

where an investor holds a long position in an asset and writes (sells) call options on that same asset in an attempt to generate increased income from the asset. 

This is often employed when an investor has a short-term neutral view on the asset and for this reason hold the asset long and simultaneously have a short position via the option to generate income from the option premium.

For example, let's say I own shares of the HINDALCO and like its long-term prospects as well but feel in the shorter term the stock will likely trade relatively flat, perhaps within a few Rs up and down of its current price of, say, 150. If you sell a call option on HINDALCO for 160 Rs, you earn the premium from the option sale but cap your upside. One of three scenarios is going to play out:

• HINDALCO shares trade flat (below the 160 Rs strike price) - the option will expire worthless and you keep the premium from the option. In this case, by using the buy-write strategy you have successfully outperformed the stock.

• HINDALCO shares fall - the option expires worthless, you keep the premium, and again you outperform the stock.

• HINDALCO shares rise above 160 - the option is exercised, and your upside is capped at 160 RS, plus the option premium. In this case, if the stock price goes higher than 160 Rs, plus the premium, your buy-write strategy has underperformed the HINDALCO shares.

1 lot of HINDALCO has 2000 shares ( which approximately translates into 2000 X 150 =  3 lakh Rs  investment). almost all of the lot of different stocks is in the same range. Now lets see how near month price is for different strike price of HINDALCO 
=====================
Strike price     Premium 
150                  8.55
152.5               7.15
155                  6.25
157.5               5.40
160                  4.50
=====================
At strike price of 160, which is OUT-OF-THE-MONEY, call option can be relatively safely sold and premium of 4.5 Rs, which translates into  4.5 X 2000 = 9000 Rs , from an investment of 3 lakh, which translates into 3 % monthly return (36 % annual return  Quite decent return !!!!) 

A more sophisticated investor can use future in place of stocks to implement the same strategy, but the risk involved and skill requirement is quite high. 

Source : Wikipedia

This strategy is best used when the investor would like to generate income off a long position while the market is moving sideways. It allows an investor/writer to continue a buy-and-hold strategy to make money off a stock which is currently inactive in gains. 

The investor/writer must correctly guess that the stock won't make any gains within the time frame of the option; this is best done by writing an out-of-the-money option. 

A covered call doesn't have as much potential for reward as other types of options, thus the risk is also low.

Time Decay

The passage of time has a positive impact on this strategy, all other things being equal.  As expiration approaches, an option tends to converge very fast on its intrinsic value, which for out-of-money calls is zero.

Main point of this strategy :

1. It has limited profit potential.
2. It has unlimited loss potential.
3. Once the strategy is introduced, reduction in volatility is beneficial for this strategy.

A note of caution

As long as the short call position remains open, the investor isn't free to sell the stock. It would leave the calls uncovered and expose the investor to unlimited risk by making it a naked call.

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Investing in stock market? make sure you read these.

There are two kind of person,who , operate in the stock market. One with little or no experience but lot of expectation and no strategy  and other with experience gained through knowledge and self correction over years. It is a wise saying in the stock trading community that at the end of the day both exchange their assets and go home. With former gaining or learning a meaningful lesson with the expense of his money and later taking the money for his experience and expertise.

So, how can a newbie in the stock market reduce his learning curve and make it more steeper ? How a normal and small investor could make a consistent gain without fear of losing his capital ? How much a investor should invest, what should be his risk profile, depending on it where should he put his money--- I will try to answer these generic questions in my articles here on this blog so explore it and try to whet your skills of investing with additional insight.

Before jumping  into the ring, you must  know your risk profile. Each person has unique environment and responsibilities. so, risk profile is also unique to individuals. Personal risk tolerance may be quite different for different genders. Men are generally comfortable with high risk handling but with additional responsibilities of their family their risk profile changes to less riskier. There are several factors, which determine one's risk profile, such as :

1. Age
2. Current level of income and asset
3. knowledge and experience
4. Family situation
5. Major future events

All of these factors determine your risk profile. All these above factors can be summarize in on line " How much you can afford to lose at this point of time? "
Will it change the your living condition if you lose all of it?

If you want to measure your accurate RISK PROFILE free of cost ,click on the link. It will take around 30 minute to answer all the question and it is worth while.


Now i know my risk profile ? what next.....

The next step is familiarization of some basic financial terms. I will suggest you to visit NSE (National Stock Exchange ) website and explore as much as you can. For basic understanding of Indian financial market READ THIS.

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