Strategy Name – Covered Call
Interim – Cashflow ! – This strategy if properly implemented can actually give you cashflows every month in terms of option premium . Thus without selling the underlying stock you are getting a cashflow ( Kind of dividends )
When to be implemented? – When you own a stock and want to gain from its temporary downside phase but don’t want to actually sell it . You basically sell a OTM (Out of the money ) call on the stock you own and collect the premium for the same , assuming stock price is not going to cross the OTM strike you have sold, and if it does , you will deliver the stocks you already own ( you need to have a position in underlying stock ), hence the position is known as COVERED CALL.
Lets take a live example , suppose you own 50,000 shares of Suzlon Energy at say @ 12 Rs in your equity portfolio and the current market price is 8. Now you are aware that there some headwinds in the market and Suzlon is going to be in range of 8 to 10 at least for next few months until sector recovers.
You sell a 14 @ OTM call Aug 2019 series on Suzlon which has a premium of .10 , so premium collected by you will be 0.10 x 45000 ( Lot size ) = 4500. Wow , Rs 4,500 for doing absolutely nothing! .
Imagine you can do this every month by selling the OTM options unless the price recovers to 14, most informed traders do that .
Now if stock remains below 14 you get to keep the premium , however in case the stock reaches 14 you are obligated to deliver the stock since you sold a call on it, but chances of this reaching 14 are slim because its difficult for a stock to rise so much in a single series ( speculation ).
• Interim cashflows without actually selling the stock .
• Target price realisation ( if the stock hits 14) you gain 2 ( 14 -12 ) in selling the stock + keep the premium also.
• Position is covered (since you are holding the underlying stock )
• You can actually earn every month by selling OTM options.
• You will have to place margin in the broker account as you are selling an option.
• There are slim chances of stock reaching the OTM strike and you will have to deliver the stock
• Selling options is risky as initial outflow ( margin ) is higher and maintenance margin needs to be furnished on daily basis.
Note : Many new investors tend to buy cheap options and end up buying the options as listed above . New investors wants to keep cost low so they end up paying premiums in the hope of stock going up almost by 100% .
Covered call are often fishers who look for new traders who wants to buy their OTM calls!