The 6-Week Options Trading Kickstarter: Covered Calls
Steve Smith breaks down a popular options strategy.
A trader can adjust the risk/reward by adjusting the strike price and expiration date of the call sold. Selling options that are close to being in-the-money can bring in more premium up-front, but there is a higher probability of having the shares called away, limiting upside.
Another tradeoff comes in the form of volatility. A covered-call strategy works best, and will outperform a plain long-stock position, when shares are stable, or trending only moderately higher.
That's an apt description of low-volatility stocks, where premiums collected will comparatively low. For example, with AT&T (NYSE:T) trading at $38, the September $40 calls, which have an implied volatility (or IV) of 16%, can be sold for $0.18, giving a return of less than one-half of 1% if the stock stood still.
For comparison, let's take a look at Sourcefire (NASDAQ:FIRE), which is trading at $46 per share. The September $50 call, which has an IV of 55%, can be sold for $2.45, providing a 5% return if the stock stood still. And note that the Sourcefire calls are 8% out-of-the money (or OTM) while the AT&T calls are only 5% OTM. This means that Sourcefire also has more room for upside gain.
But let's also note that AT&T has a 4.7% annual dividend yield, which helps close the performance gap. In this low interest rate environment, writing calls against dividend-yielding stocks can be a decent way to boost income.
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