What is a Covered Call？Option Strategy Series 1
The covered call is one of the first options strategies that many beginners understand. Today we will talk about what a covered call is.
We still use the example in the last post on how to calculate the gain and loss of the option.
In the last post, I introduced the role of an agent when selling call options. Why not use the landlord? The main reason is the landlord owns the house. If I use the landlord instead of the agent, that is a covered call.
In this example, the landlord worried that the price of the house would not rise by more than $6m in the next 6 months, so he signed a contract with Jack. Jack has the right to buy a house at a price of $6m in the next 6 months. Jack can't afford the house now, but he thinks the price of the house will rise in the future. So he signs the contract with $0.05m as a premium.
If the house price is $6.5m before the expiration date, the landlord is obliged to trade with Jack. The landlord's loss is $6.5M-$6M-$0.05M=$0.45m.
If the house price is $5m before the expiration date, Jack will not execute the right. So the landlord earns the $0.05m premium.
If the house price is $5.5m before the expiration date, Jack will not execute the right. The landlord will earn $0.05m. If he sell the house at the price of $5.5m, the gain is $5.5m-$5m+$0.05m=$0.55m
Therefore, the biggest gain for the landlord is $6m-$5m+$0.05m=$1.05m
One feature of the covered call is that once the exercise price is confirmed, the maximum profit of the trade has been confirmed. The maximum profit amount = the exercise price - the current price + the premium. Even if the exercise price exceeds the exercise price you set, the landlord's profit is still fixed.
However, the price of the house may rise, but also fall. If the price of the house falls to $4m before the expiration date, Jack will definitely not exercise the option, and the landlord will earn $0.05m of premium. Although the price of the house has fallen, the house does not need to be sold.
Similarly, when you hold the stock, if the stock price is expected to rise in a limited amount in the short term, or the stock cannot break through a certain price, you can lock in a part of the profit in advance in this way. If the stock price does not break through the strike price before the contract expires, you will earn the premium. But if the forecast fails, the profit amount is limited.
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