Alex can simply sell the stock and close the position. and Stocks That Went Up in 2008 or What Goes Up When Stocks Go Down? With this in mind, she decides to sell a call option with a $99 strike for $2 instead of a call option with a $100 strike for $1.50 agsint her Income Streams, Inc. shares. Click Any Topic Below to Go Straight To It. By writing short-term deep in the money calls on blue-chip stocks, a conservative investor can earn 6% to 9% a year without taking much equity risk. This would be offset by a loss on the stock of $300 ($.50 per share assuming she sold it at $18 on Monday morning following option expiration) leaving her with a, The option buyer could simply buy the stock for less than the strike pri. Additionally, many investors sell covered calls in IRA’s to eliminate, defer or reduce taxes. You can see why covered calls can be a great income generator for stock investors who are already exposed to stock market risk anyway. aving all your covered calls exercised each month provides capital for fresh positions, without having to allocate more capital to stocks designated for covered calls. This was the case with our Rambus example. The stock can fall 38% and still not have a loss, and there is no risk on the upside. On that strike, there is $260 in time premium available. After a covered call is exercised, the capital used to own the stock is available for new covered call positions. One of the practical applications of selling cash-secured puts is to buy shares “at a discount” In my books and DVDs I use out-of-the-money puts in lieu of setting limit orders in order to accomplish this goal. Does Living Off Covered Calls Really Work? In this next possible outcome, assume Retire Corp closes below $18, or deep in the money. Click here to get my eBook with our favorite 9 income generating strategies that build wealth, too. It’s easy for investors to get lured into writing covered calls because the income is so high relative to dividends. Contrary to popular belief, selling covered calls slightly reduces stock risk over owning stocks outright without a covered call strategy sold against them. Now that you’ve seen the factors to consider before choosing an in the money covered call strategy specifically, let’s look at the math with an example. Remember, the further away the strike price is above the current stock price, the less income generated since the option premium (price) gets lower as it moves further up and away from the stock price. While there is no room to profit from the movement of the stock, it is possible to profit regardless of the direction of the stock, since it is only decay-of-time premium that is the source of potential profit. This is simply because the strike price is lower with an in the money covered call strategy than it is with an at the money or out of the money covered call strategy. because when an in the money covered call is exercised, the option seller. What Happens at Options Expiration for in the Money Covered Calls? Figure 2 - RMBS May 25 in-the-money call write profit/loss. So, by owning 600 shares of Retire Corp, Alex was able to sell the 6 option contracts. ♣  It’s super important to remember that when you sell in the money covered calls, you know that you may have to sell the stock at a loss. Deep In The Money … In this case, an in the money covered call strategy may work the best as you’ll see in the example later. excluded from the calculations in this post. you may have an insight into an upcoming event. If so, this loss will offset the income generated from selling the call option as explained more ahead. If the stock drops to $97 by the option expiration date, the option won’t be exercised. This will be the underlying stock against which she sells call options for some extra income. Establishing a Deep In The Money Covered Call is extremely simple. The worse thing for covered call writing is, bear markets so let’s see how bear markets affect in the money covered call strategies when compared to other covered call strategies. Potential Return on in-the-Money Call WritesAs you can see in Figure 2, with the May 25 in-the-money call write, the potential return on this strategy is +5% (maximum). Looking at another example, a May 30 in-the-money call would yield a higher potential profit than the May 25. Selling Deep In The Money Calls Example Let's say you like McMoRan Exploration (MMR, oil & gas company). Looking at the May 25 strike, which is in-the-money by $13.60 (intrinsic value), we see that there is some decent time premium available for selling. The worse thing for covered call writing is experiencing bear markets so let’s see how bear markets affect in the money covered call strategies when compared to other covered call strategies. The option buyer didn’t exercise the option since the market price of the stock on expiration day is below the strike price. It was a little bit of a bummer for Alex because the stock had dropped in value since it was bought at $18.50. They should be considered based on your own situation and commission structure. A fence is a defensive options strategy that an investor deploys to protect an owned holding from a price decline, at the cost of potential profits. Summary for In the Money Covered Call Strategy. Your email address will not be published. Also, the potential rate of return is higher than it might appear at first blush. As you can see in Figure 1, it would be possible to sell a May 55 call for $2.45 ($245) against 100 shares of stock. The Bottom LineCovered-call writing has become a very popular strategy among option traders, but an alternative construction of this premium collection strategy exists in the form of an in-the-money covered write, which is possible when you find stocks with high implied volatility in their option prices. However, for retirees and others living off investments who count on covered calls for income, bear markets can present a real challenge. How Does an In the Money Covered Call Strategy Work? Buying options is a lot like gambling at the casino. are profitable, but many are, and they can be an excellent income source. Sell a Call Option After Stock Rises. As you may have guessed, not all in the money covered calls investments are profitable, but many are, and they can be an excellent income source. Likewise, new covered call trades each month tend to generate more income, easier. Risk is permanently reduced by the amount of premium received. Keep in mind this is income from one month’s profit from just one covered call position. On the other hand, if you struggle to find new covered call positions, out of the money call options may be more convenient since they’re less likely to be exercised than in the money covered calls. Before we begin… Did you know that most traders are always trying to score big… driven by the burning desire to hit it big. If used with margin to open a position of this type, returns have the potential to be much higher, but of course with additional risk. While it’s not completely under your control whether a call option gets exercised, the covered call strategy used will definitely affect the probability that positions will get called at option expiration. An in the money covered call strategy usually generates higher income while reducing or eliminating capital gains. You’ll want to decide if you prefer that your covered calls get exercised or not. Again, this means that in the money covered call strategies generate higher income than out of the money covered call strategies. As you can see in Figure 2, with the May 25 in-the-money call write, the potential return on this strategy is +5% (maximum). In this case, the option buyer may or may not “exercise” the call option. But the good thing is that Alex gets to keep the $ 1.40 for selling the option, which reduces her Retire Corp position cost per share cost to $17.10. Alex’s annualized return on this in the money covered call strategy would be: Option Net Profit/Cost of Retire Corp$ .90/18.50 = .049 x 12=59% annualized. . This would be offset by a loss on the stock of $300 ($.50 per share assuming she sold it at $18 on Monday morning following option expiration) leaving her with a profit of $500. Therefore, we have a very wide potential profit zone extended to as low as 23.80 ($14.80 below the stock price). Your email address will not be published. If you hate managing covered calls, in the money strategies may be best for you since more in the money covered call positions get exercised than at the money or out of the money covered call strategies. This works especially well with in the money covered calls since the overall position cost is lower due to the high option premium. Trade deep in-the-money calls to increase yield on a stock and lower the downside risk. That's over three times what highly rated bonds pay. You can then sell the underlying stock, buy back the short calls … If increasing stock income by selling covered calls is the primary objective, it’s worth considering in the money covered call strategies. An employee stock option (ESO) is a grant to an employee giving the right to buy a certain number of shares in the company's stock for a set price. One last advantage for in the money covered call strategies is that having all your covered calls exercised each month provides capital for fresh positions without having to allocate more capital to stocks designated for covered calls. And then the game is over. This occurs with out of the money covered call strategies but not with in the money covered call strategies. Because 90% of traders who buy options without having an edge lose money. (Find out about another approach to trading covered call. Investopedia uses cookies to provide you with a great user experience. Traditional Covered-Call Write Let's look at an example using Rambus (RMBS), a company that manufactures and licenses chip interface technologies. Instead of selling another call option right after option expiration, Alex can watch the stock chart with the plan to sell a call option near the top of the current trading range to get a higher option premium. ♦Risk Management Tip♦  All investors will want to confirm that investing in stocks is within their own acceptable risk level before even considering using any covered call strategies. Clearly, the risk/reward seems misplaced. ♦Income Stream Tip♦  Selling call options on high dividend stocks can make sense for investors who always want at least a little income from stocks. ♦In My Experience♦ I usually enter in the money covered call strategies, however, with the expectation that the stock will temporarily decrease in value. Read on to find out how this strategy works. Most investors just assume selling covered calls is risky since it involves options. As you may have guessed, selling covered calls is one of them! My Ultimate RISE Wealth Plan is the best place to begin if you’re interested in designing your own unique, slightly alternative plan to live well for life...Be forewarned; it’s not for the faint of heart. . This is because the cost basis is much lower due to the collection of $1,480 in option premium with the sale of the May 25 in-the-money call option. Required fields are marked *. Get my free eBook with our top 9 strategies to build wealth while generating income. Otherwise, I’d sell an out of the money covered call. ♦Income Stream Tip♦  To understand why covered calls can be an excellent income generating strategy for those living off investments, compare covered call income to typical stock dividend income. It’s a fool’s errand. If the overall market is trending down, however, it usually makes more sense to sell in the money covered calls than out of the money covered calls as explained below, IF you choose to stay invested in stocks despite the decline. * ABC Jan 45 calls trading at $18.50 (These are in the money by three strike prices.) That … Now a deep in the money option usually has a delta of .60 or above meaning that the option will move $.60 cents for every dollar move in the underlying stock. In other words, if we sold the May 25, we would collect $120 in time premium (our maximum potential profit). For options, both a call and a put option can be in the money. While the underlying stock price will have drop by the dividend amount, the written call options will also register the same drop since deep-in-the-money options have a delta of nearly 1. For a more comprehensive breakdown on the different strategies Click Here To Read… Selling Options To Boost Your Income . – Buying an in the money LEAPS call – Selling an out of the money call with a near-term expiration date. Remember, the prior month, the stock was at $18.50. the money covered calls as explained below, Out of the Money Vs In the Money Covered Calls in Bear Markets, income generated since the option premium (price) gets lower as it moves further up and away from the stock price, Second, if you’re selling out of the money covered calls, ince the market is declining, it is harder to sell call options near your stock. The deep in-the-money sale often is a form of a buy-write trade. income while reducing or eliminating capital gains. Fortunately, there are some advanced covered call management strategies that can be used during stock market downturns. You buy the stock and sell covered calls that … This allows you to sell call options repeatedly against the same stock position, thereby reducing the need to find additional suitable stocks. ♦Income Stream Tip♦  The same stocks can be used for covered call strategies repeatedly, sometimes around dividends or earnings news. And who doesn’t want higher income for the same amount of capital at risk? Stock Closes Out of the Money on Option Expiration, Lowering Stock Risk with In the Money Covered Calls, The stock price is expected to decrease near term, The call seller wants the option to be exercised. But there is very little downside protection, and a strategy constructed this way really operates more like a long stock position than a premium collection strategy. The deeper in the money the call option is, the greater the probability it will get exercised. Assume Retire Corp closed at $19.00, or out of the money. Sell a deep in-the-money strike with a 2% time value premium and downside protection of that profit; … The option buyer could simply buy the stock for less than the strike price of $18 so there would have been no reason to exercise the option. Since in the money covered calls are more likely to get exercised as stocks drop, they are generally a better choice than in the money covered call strategies in declining markets. The near … Alex can sell another call option for the next month against her shares in Retire Corp. We can begin by looking at the prices of May call options for RMBS, which were taken after the close of trading on April 21, 2006. Read my related post on the cash allocation in a portfolio. The Problem. Understanding the Strategy May Be More Straightforward by Using an Example: Step … An in the money covered call strategy involves selling a call option with a strike price lower than the cost of the underlying stock. At the time these prices were taken, RMBS was one of the best available stocks to write calls against, based on a screen for covered calls done after the close of trading. Books about option trading have always presented the popular strategy known as the covered-call write as standard fare. Option 2. Selling call options against shares you already hold brings in guaranteed money right away. she is okay with that since she did the math, for all 3 possible option expiration outcomes, can be a great income generator for stock investors. But there is another version of the covered-call write that you may not know about. At this point, Alex has several options you can see below. stick with me because it’s important because it makes the math on in the money covered call strategies easy to understand. RMBS closed that day at 38.60, and there were 27 days left in the May options cycle (calendar days to expiration). This strategy is commonly used when the call writer expects the stock price … Before we begin… Did you know that most traders are always trying to score big… driven by the burning desire to hit it big. Option premiums were higher than normal due to uncertainty surrounding legal issues and a recent earnings announcement. It makes more sense—instead of buying 500 shares of ABC stock at $60 (for $30,000)—to buy five of the ABC Jan 45 calls … An option is said to be "deep in the money" if it is in the money by more than $10. price since the option prices have declined with the stock price. The income generated from selling covered calls usually ranges at least two to twenty times that of typical dividend income! Remember, the higher income trade off with in the money covered call strategies is that the stock can be called at a loss. Note that many covered call writers prefer to open new positions every 4 to 6 weeks for minimal effort with good income, but there are many other covered call time frames, including weekly options, how much time you want to spend on your income streams, and wealth building strategies from your lifestyle, Like Ali, you may have checked a stock chart and seen that the stock is at the high end of the recent trading range, f you’re new to stock charts, while technical analysis can seem daunting, v. ery basic technical analysis can be an incredibly valuable tool for evaluating the best covered call strategies. What a savings! A ratio call write is an options strategy where one owns shares in the underlying stock and writes more call options than the amount of underlying shares. Assume the option buyer did not exercise the option by buying the stock. Sometimes you can even find a deep in the … Why? Stock is trading at 16.91 with $1 increment strikes so any option with a strike of 15 or less … Everyone knows what deep in the money calls means. By using Investopedia, you accept our. This is one reason so much income was generated from this particular covered call; it was a deep in the money covered call strategy. And these higher premiums lower the biggest risk of using covered call strategies: risk of the underlying stock dropping due to either the overall market or stock specific bad news. They should be considered based on your own situation and commission structure. Unless Alex buys back the call option, what happens on options expiration depends on the price of the stock on June 15, the third Friday in June that year, so let’s look at that next. You’re betting for a specific outcome … By using a DITM strategy, you can accomplish several things: Lower your cost of entry into a stock that … Likewise, offset, however, by the reality that managing unexercised covered calls, doesn’t generate as much income as new monthly trades. And after investing in stocks for almost 40 years, I’ve learned the importance of addressing risk management before even considering any investment, so let’s do that first. In this case, Alex would have made $800 from selling the call options. Either way, Alex kept the $800 from the option sale. y owning 600 shares of Retire Corp, Alex was able to sell. And, of course, covered calls can be sold on etf’s of other asset classes that often move counter to stocks, such as bonds, or sometimes gold. Nevertheless, covered call strategies work best and are the easiest to implement in sideways or upwardly trending markets. And, of course, some stocks do well during bear markets. Because 90% of traders who buy options without having an edge lose money. Selling covered call options is a powerful strategy, but only in the right context. Taxes and brokerage commissions are excluded from the calculations in this post. A collar, commonly known as a hedge wrapper, is an options strategy implemented to protect against large losses, but it also limits large gains. My experience has been that usually the very first covered call on a new position has the best return over ongoing, managed positions, giving me a bias toward at the money or in the money covered calls. This traditional write has upside profit potential up to the strike price, plus the premium collected by selling the option. If you can live with less downside risk and you sold the May 30 call instead, the potential return rises to +9.5% (or +131% annualized) - or higher if executed with a margined account. sell covered calls in IRA’s to eliminate, defer or reduce taxes. This article is going to cover selling deep in the money (ITM) puts. It’s important to note that Alex immediately got $800 deposited into her brokerage account for the sale of the options which she gets to keep regardless of what the stock price does. Plus, … over the past 15 years from real estate, stocks, and online business. In this case, the option buyer may or may not “exercise” the call option (buy the shares of Retire Corp) since the option strike price is the same as the market price on option expiration. There is a trade off for this income, however, and more to consider as explained below. If we were going to do a traditional covered-call write on RMBS, we would buy 100 shares of the stock and pay $3,860, and then sell an at-the-money or out-of-the-money call option. Read my related post Does Living Off Covered Calls Really Work? If we were to annualize this strategy and do in-the-money call writes regularly on stocks screened from the total population of potential covered-call writes, the potential return comes in at +69%. Investment capital allocated to covered call selling can get completely tied up with little if any income from stocks during bear markets. And this happens immediately after the call option is sold against the stock. A zero cost collar is an options strategy used to lock in a gain by buying an out-of-the-money (OTM) put and selling a same-priced OTM call. Downside protection from the sold call offers only 6% of cushion, after which the stock position can experience un-hedged losses from further declines. Sell a Call Option with More Time Value, from selling the call options. Selling deep in-the-money call options represents an innovative approach to obtaining high probability yields. ♦Wealth Building Mindset♦ Always evaluate potential best and worst case investment outcomes, then accept and learn from what occurs. This strategy is commonly used when the call writer expects the stock price to decrease, or to increase the probability of the option being exercised. Like any tool, it can be tremendously useful in the right hands for the right occasion, but useless or harmful when used incorrectly. Before deciding whether to use an out of the money, at the money, or an in the money covered call strategy, consider the above factors, overall stock market direction and your own financial goals for building wealth or income. set to significantly lower stock risk when selling covered calls. And, of course, some stocks do well during bear markets. Cash collected up front can be … When found, an in-the-money covered-call write provides an excellent, delta neutral, time premium collection approach - one that offers greater downside protection and, therefore, wider potential profit zone, than the traditional at- or out-of-the-money covered writes. Read Trade The Covered Call - Without The Stock.). The short call is covered by the long stock (100 shares is the required number of shares when one call is exercised). When this happens, unfortunately, all your covered call capital gets tied up in those covered call stocks that didn’t get exercised! This is because the call option income offsets the cost of the stock the minute the call option income hits your brokerage account. for more on covered call risk. Now that risk from covered call strategies has been addressed, and how in the money covered calls can be the least risky strategy, lets’ see how an in the money covered call strategy, specifically, works, as opposed to other covered call strategies. The six-month (December) deep-in-the-money 1050 call is now trading for $131, meaning you can initiate the long side of the trade for $13,100 instead of $115,500. The May 25 call has $1.20 ($120) in time premium (bid price premium) value. In this case, Alex would have made $560 on the overall position as follows: Net Profit per Share                   $.90, Number of Shares                       600, Total Profit                           $560. A call option is an agreement that gives the option buyer the right to buy the underlying asset at a specified price within a specific time period. In this example, I multiplied the option equation above by 100 because 1 option contract equals 100 shares of stock. You’re betting for a specific outcome with odds of winning a mere 25% to 40%! She would be close to breaking even on the overall position if she sold her stock at option expiration. Note that since the stock price has dropped from her purchase price of $18.50, the income generated will not be as good as the prior month since the stock price (and related option) is lower. And who doesn’t want higher income for the same amount of capital at risk? Figure 1 - RMBS May option prices with the May 25 in-the-money call option and downside protection highlighted. than out of the money covered call strategies. . This is because the entire position can be entered into based on the optimal income initially. If you’re interested in creating diversified income streams and investing strategies other than passive stock and bond portfolios, you’re in the right place; this site is about our (mine and hubby’s) journey to financial independence following our late midlife epiphany that we needed to make some shifts in the way we were investing if we wanted funds for life. price with an in the money covered call than an out of the money covered call. Based on your overall wealth plan, you may find that you want income more than capital gains. The, Higher Income from In the Money Covered Calls. Even after evaluating the potential outcomes, remember that, while charts and information can be used to guide us, no one can know for certain the stock’s price at option expiration since it’s in the future. An in the money covered call strategy involves selling a call option with a strike price lower than the cost of the underlying stock. Income from Covered Calls Vs Capital Gains. . While it’s not completely under your control whether a call option gets exercised, the covered call strategy used will definitely affect the probability that positions will get, If you hate managing covered calls, in the money strategies may be best for you since mo, in the money covered call positions get exercised, than at the money or out of the money covered call strategies, This is simply because the strike price is lower with an in the money covered call strategy than it is with an at. This is why it’s the strategy at Options … On the other hand, managing covered calls is probably a little less work than finding new covered calls to sell every month. Read my related posts: Are Covered Calls a Good Idea? For further reading, see Come One, Come All - Covered Calls. The strategy I implement with my deep in-the-money calls is to buy with a strike date four to seven months in the future in order to provide leverage and downside protection over a long period … As you can see, all the profit from this covered call investment came from the sale of the option premium, as is often the case with in the money covered call strategies. While there is less potential profit with this approach compared to the example of a traditional out-of-the-money call write given above, an in-the-money call write does offer a near delta neutral, pure time premium collection approach due to the high delta value on the in-the-money call option (very close to 100). If you enjoy researching stocks and easily find new ideas for covered calls, you may want all your covered call positions to get exercised so you can enter new positions more often. This is calculated based on taking the premium received ($120) and dividing it by the cost basis ($2,380), which yields +5%. However, in order to compare a monthly or six week return to an annual return, such as dividend income of 3% a year, it helps to calculate covered call returns annualized. DISCLAIMER: Nothing in this post is meant to be taken as personal financial advice. Alternatively, you may have an insight into an upcoming event, such as company earnings or a new competitive product, that will likely cause the stock to drop, ideally on a temporary basis only. And since the market is declining, it is harder to sell call options near your stock purchase price since the option prices have declined with the stock price. Let’s say that Ali buys 100 shares of stock in Income Streams, Inc, for $100. Our Income Stream, Wealth Building Adventure Later in Life. Read my related post to see how a stock market crash will affect you. In this scenario, Retire Corp closed at exactly $18, or at the money. The formula for calculating maximum profit is given below: This is offset, however, by the reality that managing unexercised covered calls doesn’t generate as much income as new monthly trades. since the option strike price is the same as the market price on option expiration. There is, You’ll want to decide if you prefer that your covered calls get exercised or not. (Read my related post What Goes Up When Stocks Go Down?). ers living off investments who count on covered calls for income, bear markets can present a real challenge. An option is said to be "deep in the money" if it is in the money by more than $10. ♦Wealth Building Tip♦ All investments are bad if they take an investor outside of acceptable risk while too little risk can hinder investment returns. Let’s look at the third possible outcome at option expiration with her Retire Corp in the money covered call strategy. 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