Are you interested in trading and investing but need help knowing where to start? Learning about covered calls may help. Covered calls can be an excellent tool for traders looking to increase their profits while mitigating some of the risks commonly associated with investing.
This article will dig deep into covered calls and how they are used in modern-day trading. Not only will you learn the basics of covered calls, but we’ll also go over some advanced tactics experienced investors use when creating their portfolios. So read on and explore the world of covered call options today.
What are covered calls, and what is their purpose?
Covered calls are among the most popular trading strategies; they help traders with a low appetite for risk maximise their advantages and protect their downside. A covered call involves simultaneously purchasing, or holding, a specific asset like stocks and then writing or selling a particular call option on the same asset. By allowing another party to buy your asset at an agreed-upon price, you can collect additional income from premiums paid by the buyer.
This additional income helps to offset the cost of owning the stock and increases overall profits, provided the stock does not increase significantly in value beyond that agreed-upon strike price. Covered calls help lessen losses during bear markets. They can also be used in bull markets to supplement income from holding stocks while capturing potential upside growth should prices rise beyond that original strike price. For those who are interested in using covered calls, Saxo has various options to help you get the most out of your covered call strategy.
How do you execute a covered call trade?
Now that you know what a covered call is and how it can help improve your overall trading strategy, let’s discuss the mechanics of executing a covered call trade. To begin, you’ll need to decide on the asset you want to purchase and then buy it at its current market price. Next, you’ll need to determine the strike price of your call option, meaning the price at which you are willing to sell the asset should it increase in value beyond this level.
You’ll then need to find a buyer willing to pay a premium or fee for the option. Once an option is purchased, you’re considered short on that particular asset, and the buyer is considered long. Finally, you’ll need to monitor the asset to ensure your covered call strategy remains successful.
The benefits of using covered calls
There are many benefits to using covered calls as a trading strategy. The most obvious benefit is the potential for increased income through premiums received from options buyers. Premiums provide an additional source of income that can be used to offset losses or serve as extra earnings, depending on how successful trades are.
Covered calls also reduce risk since it’s impossible for the stock to go lower than the agreed-upon strike price. It is especially beneficial when trading in a bear market since it allows traders to protect their downsides. Additionally, covered calls help traders take advantage of volatile markets with minimal upfront risk or capital requirements.
Finally, covered calls are an excellent tool for creating diversified portfolios and mitigating risk across different asset classes. By writing covered calls on multiple stocks, traders can benefit from the positive correlations between assets while taking advantage of the income earned through premiums.
The risks associated with using this trading strategy
While there are many potential benefits to using a covered call strategy, it’s essential to understand the risks associated with this type of trading. Depending on how far the stock falls in a bear market, traders could still suffer losses despite writing options. Additionally, if the stock rises beyond the agreed-upon strike price, traders stand to lose potential opportunities since the asset will generally be sold at the lower strike price.
It’s also important to note that while collected premiums can provide additional income, traders should always factor in commission and other trading fees before making any final decisions on their strategy’s success. Additionally, the complexity of this type of trading makes it essential to understand all the terms and conditions associated with writing options before executing any trades.
Examples of how to use a covered call in your trading plan
One famous example is to purchase a stock and then write options against it for additional income. It allows traders to take advantage of premiums while capturing potential upside from increased prices.
Another option is to use covered calls as a form of hedging. For example, if you own stock in an energy company but believe oil prices could decline shortly, writing covered calls against your position would help reduce exposure to any losses resulting from a decrease in oil prices.
Finally, some traders use covered calls to increase their overall return on investment. It typically involves writing multiple covered calls against different assets and taking advantage of the premiums associated with each asset. The goal is to leverage the income generated from premiums to achieve higher returns than investing in a single stock or asset class.