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I am reviewing trading options. I'm looking to sell some shares of 2 companies but from what I am reading it may make more sense to buy covered calls at the price I'm willing to sell & keep the premium. Am I correct in my understanding of this strategy?

  • Not sure about the part where you're saying "& keep the premium". As a call buyer, you will have to pay the premium. This is a strategy that may be worth its salt depending on your circumstances but that is probably not fit for most day traders. I would bet that in most circumstances you will end up at best recouping some of your premium paid. You will need quite a bit of variance (above expected variance of course as variance is priced into options) to be profitable either way. – ApplePie Apr 29 '18 at 15:56
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Let's start with some confusion in the wording of your question.

A covered call involves owning the stock and selling a covered call. This is also called a Buy/Write and when placing a simultaneous order that involves executing both positions, it is a buy order to open (buy stock and sell the call). If you already own the stock then you place a sell order to open the short call position thereby creating a covered call. If you don't own the stock and you only sell the call to open, you are selling a naked call. And FWIW, a covered put means that you are short the stock and short the put.

Where the confusion arises is that some oldtimers call the outright buying of a put or a call "Buying naked options" since there is no stock involved. It's confusing and is not the common terminology used today. A better description would be "buying long calls" or "buying long puts". No confusion there.

Since you own the stock and you are looking to sell some shares and collect a premium, you are selling (not buying) short calls and the result is a covered call. So yes, you are correct in that If the stock cooperates and is above the short strike at expiration, the short call will be exercised by the owner of the call. You will be assigned and you will receive the strike price and keep the premium as well. If the stock is below the strike price at expiration, you will keep the stock and keep the premium, giving you the opportunity to sell another call for a later expiration, if so inclined. You may be assigned early if there is a decent sized dividend and the call is deep enough in-the-money (the stock price is above strike price) and your short call trades below parity.

FWIW #2: A covered call is equal to a short put so it usually makes more sense sell a short put instead of buying a B/W (simultaneous order) since it will involve less frictional costs (B/A spread and commissions) if it works out. Make sure to factor upcoming dividends into the equation since they affect the relative value of the respective put and call.

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