Covered call is one of the most traditional strategies but is very effective in time likes now. Little bit of support boosts your confidence in taking that trade you would not have taken.
Shubham Agarwal
August 20, 2022 / 09:20 AM IST
Confidence and conviction in directional trading often comes from the fact that there is a long way to go for the stock. The potential move could take the stock beyond the target price. This confidence comes down a fair bit when we know that the underlying for example Nifty has already posted a rally of around 10% from the lows.
Now, would it post yet another 10% in recent time may be, maybe not. This is one such situation that needs some assistance from the Options with a Strategy where Continuation of Trend is Awarded but Pull Back is at least Rewarded.
One such strategy is Covered Call. Covered Call is a trade where we go Long (Buy Position) in the Underlying Cash/ Preferably Future) and at the same time Sell (Short) Call with Strike Price closer to the Target Price.
Whenever we already have a move in place and we are betting on continuation, there are 2 risks that we need to be worried about. One is Price correction, and another is Time correction. Covered Call checks both the boxes.
With Sell Position in Call, if the underlying goes lower we make up part of our losses in Underlying Future from fall in Call premium (which is short). On the other hand, if underlying takes a few days before giving us the move, the passage of time creates profit in Call (reduction in Premium due to passage of time).
Sounds really good, now What is the catch?
Our Profits are limited to the difference between Call Strike Price and Underlying Buy Price + Premium Received. Now on the day of expiry this is not much of a pain because we were going to exit the stock at the target price. However, if the Target Price comes before expiry we will get much less profit. Due to rise in underlying there will be Losses in Call sold.
This is the only catch. The pain will be lesser with more the time spent in achieving the Price Target. However, there will be pain. At the same time as discussed earlier both time and price correction will reward us.
Let us face it, we are anyways not expecting the underlying to rocket past our target any time soon because there is already a move in place.
Now the exit strategy. Remember, the sell Call is NOT Equal to Buy Put. So, it is in no sense a hedge. What this means is that we will have to have a stop loss in Underlying along with Target. If the Stop-Loss were to hit, we would get rid of the entire position Future as well as Call Option. Good part about this is that we will lose little less due to profit from Option Sell position.
Covered call is one of the most traditional strategies but is very effective in time likes now. Little bit of support boosts your confidence in taking that trade you would not have taken.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Shubham Agarwal is a CEO & Head of Research at Quantsapp Pvt. Ltd. He has been into many major kinds of market research and has been a programmer himself in Tens of programming languages. Earlier to the current position, Shubham has served for Motilal Oswal as Head of Quantitative, Technical & Derivatives Research and as a Technical Analyst at JM Financial.
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