8 ways to profit with covered calls

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The covered call trade has always been known as an income strategy as you
receive premium for selling calls against your stock. This is the most popular
rationale for implementing this type of trading. However, there are many
more dimensions that can be coupled with covered call trading to further
enhance the potential for profits. Here is a list of 7 methods to more profits
writing covered call trades.

1. Selling the classic covered call against stock you own. You make
money with the time decay of the short call. Usually you sell the near
month or next month out so you can continue to compound your
money.
2. You can sell out-of-the-money (OTM) calls as your short call. Here you
get the call premium and potential for a capital gain as the OTM call
offers some upside profits for the stock price to increase.
3. You can make more money on a short call when volatility collapses’
early in the trade and you close the trade. We have all been in covered
call trades when after a few days the call option loses value and you
find yourself in a very profitable trade. You can close this short call to
lock in profits.
4. You can trade the short call as the stock price changes. For example, if
the stock price decreases, you can close the short option early for a
profit. Then, the call can be written again when the stock prices snaps
back to higher levels. This is similar to channeling stocks by trading
the short call against stock price changes.
5. You can roll up or roll out the short calls to a higher strike price or to a
later expiration month. This allows you to squeeze extra profits out of
a stock price rise.
6. You can add option legs to a short call to create spread positions such
as a bull or bear call spread. This is good to take profits from a rising
covered call trade or a falling stock price.
7. You can add a long protective put to the covered call position as it will
increase in value as the stock price decreases. This is usually utilized
as protection against stock declines but can create more income when
a stock price declines while you are holding a covered call position.
8. You can use LEAPS as stock replacement then sell a short call against
it. This creates leverage for potential returns and puts less capital at
risk.

It is not necessary to use all of these methods when trading covered calls. It
will be advantageous to the income trader to use more than one method to
make money income from selling premiums. In addition, some of these
methods can be used to enhance and/or protect your monthly income.
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Adding these methods does require more monitoring or your covered call
positions. The advantage is that it adds more potential for profits compared
to the classic covered call trade. It really comes down to how active you
want to be in your income trading each month.

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Writing Out-Of-The-Money Covered Calls

If you are bullish on a specific stock, then you should consider writing an
out-of-the-money (OTC) covered call. This type of call includes a strike price
that is above the current stock price. You still get a call premium but it is
generally less than an at-the-money call. But you also get the potential of
stock appreciation because of the higher strike price of the call sold. This
creates a situation for potentially two income streams from one trade.

This trading strategy works best when you can confirm the stock being in an
uptrend or if the stock is bouncing off a support level. A support level would
be something like a 50-day moving average or even a Bollinger Band that
has been stretched on the bottom.

The key to this strategy is to be right about the stock price moving higher in
the near future. Due to the OTM call offering fewer premiums than an ATM
and having a low delta, they can be slow to lose value on a stock pullback.
This strategy should be used in special situations or during a slow moving
bull market.

Also, you want to avoid this strategy when he stock has gapped up until the
new price range is confirmed. Stocks that gap up usually pull back before
they stabilize in a new trading range. However, a stock slowing moving up is
a good opportunity for OTM writes.

This strategy works well when you have a down-day in the stock or market.
The stock price decline will usually be temporary down and will bounce back
in a few trading days. You need to be sure the market decline is not a
permanent correction that will be sustained for months.

This is a good strategy for stocks you do not want called away in a flat
market. You can still get an increased profit if the stock price is above the
entry price at expiration. Then, you get an even bigger return if you get
called out at the higher call strike price.

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Writing Deep-In-The-Money Covered Calls

The conservative covered call writer is seeking downside protection and
income from premium. This investor places more value on protecting capital
and is not concerned about their stock being called away. This covered call
investor will sell calls that are deep-in-the-money (ITM). This is a good
strategy when the market uncertainty increases and there is increasing
worry about a market correction.

For example, if Wal-Mart is trading at $53.00 then a deep ITM call will be
sold at the 45 strike price. This call is $8.00 ITM and provides a 15%
downside protection. With a stable stock like WMT, it probably will not go
below the 45 strike price during a market pullback. In fact, WMT has not
been below $45.00 in the last three years.

The trade-off for selling ITM calls is that the returns will be lower as the
majority of the call premium is intrinsic value. The method to the madness is
that these calls offer more downside protection in return to accepting a
lower time value of premium. ITM call writes can be a very successful
strategy when used on large-cap stocks during a market pullback.

There are many covered call traders that suggests they made a higher
return over a long time period for several reasons:

 It is not that difficult to find a 3% return with 30 days remaining on
high quality stocks;
 The stocks will be assigned at expiration so you are never stuck with a
stock that is down;
 ITM calls have a higher delta so they lose value closer to the stock.
You can easily roll down your strike price without a loss;
 Trading the short call is more profitable due to the high delta. Here
trading refers to buying back the call on a price dip and write them
again on the bounce back.

The ITM writer should concentrate on large-cap, high quality stocks as there
is never a reason to trade poor quality stocks regardless of your strategy
with ITM calls. The one item of note is that this strategy is not the best in a
rising bull market unless you have high risk avoidance to a potential trade
loss.

A variation of this trade is to use it when volatility is high such as in the

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financial crisis in 2009. The high volatility will increase the amount of
premium and return. You can use this strategy when there is a pending
event such as an earnings release but not as a speculation trade. The key is
to use this strategy with large-cap, high quality stocks.


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Writing Covered Calls With High Quality Stocks Using Volatility

This is a great strategy because it uses the highest quality stocks that high a
high volatility. I define a high quality stock as a stock rated 5 stars by the
S&P rating agency. As we know, when volatility is high you get more
premium from selling calls against your stock. This will increase your return
on investment for covered writes.

Here is how it works:

 stock volatility is higher than the market volatility measured by the
S&P 500 index (SPY);
 stock has high implied volatility to generate good call writing return on
investment;
 Stock pays an annual dividend whose yield is at least 3% or better.

Then, if not called out, you can rewrite the call month after month until you
are called away. This strategy will minimize the amount of time used in
selecting stocks and managing trades. This will also lower the stress
involved with covered call trading.

To implement this strategy, you should look for:

 A low to medium historical volatility between 20-40% but higher
implied volatility which tends to generate more premiums;
 A historical volatility of 30-60% with similar implied volatility as you
will hold these stocks for several months - the high HV will provide
more premium each month.
 Lastly, do not try this strategy on a lower quality stock just to increase
your returns - stay with the 5 star stocks.

The use of high quality stocks will lessen the number of potential stocks
because you have preselected a stock list. The high quality stocks are
generally blue-chip stocks that pay a dividend. I am not a fan of buy and
hold investing but this strategy is an effective way to maximize monthly
income from investments.

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The high quality stocks or blue-chips tend to move less in price compared to
smaller cap stocks. These high quality stocks tend to outperform during
periods of uncertainty in the markets. This is why we use these stocks in this
strategy as they can weather the market downturns and rise during a bull
market.


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Trading Covered Calls by Legging In

This strategy is a variation of the out-of-the-money (OTM) covered call
strategy. When you are anticipation a market upturn such as a bounce up or
your stock is in a prolonged uptrend, this strategy may work for this type of
situation. The legging in strategy is to buy the stock and then wait for the
price to increase before selling OTM calls. The legging in is related to the buy
the stock (one leg) before you sell the calls (second leg) at a later date to
complete the covered call trade.

This strategy can significantly increase your returns when the stock price
moves up rapidly. Then, you have a decision to make about when to sell the
call. Some traders decide that the stock will continue to rise so they do not
sell the call. Others may decide the stock is out of gas to move higher so
they will sell an OTM call for additional income.

As an example, you may purchase a stock at $52.40. The current month
52.50 call strike is selling for $1.00. You can buy the stock at $52.40 and
sell the 52.50 call for $1.00 and get an unassigned return of 2.14%. You
don’t want to lock in your covered call trade for a low return so you wait on
the stock. To leg in to this trade, you would buy the stock and wait until its
price increases to around $54.00. At this time, the 52.50 call strike price is
$2.50. The leg in trader would sell the 52.50 call strike if the stock was out
of momentum and poised for a pullback. This would create an assigned
return of 5.01%. This return is more than double the initial trade with a
downside protection to $52.50.

The leg in trade more than doubles the unassigned return because the
option premium more than doubled (from $1.00 to $2.50) as the stock price
increased. The return percentage doubled while both trades were at the
same strike price (52.50). This could be even better if the trader moves their
call strike price to 55 to let a stock continue to run up to a higher price.

So what is the trade off for the additional return? Legging-in is a little
speculative because it leaves the investor without a premium for a short

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time while waiting for the stock price to increase. Additionally, the trader
does not have the downside protection while owning only the stock without
selling the call. Lastly, the investor could be wrong and the stock never
increases in price.

The bottom-line is that the trader must have a solid reason for why the
stock will increase in price in the short-term. The moment this rationale is
proven wrong, the trader must make a decision on how to proceed with the
stock they own.


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Covered Calls on Market Down-Days

One strategy to deal with the current market turmoil is called down-day
covered writing. This is based on looking for stocks that are down on a day
that the market is down. This strategy assumes the rubber band reaction of
the stock bouncing back up when the market move up. This gives the writer
the advantage of buying the stock at a cheaper price than on a market up-
day.

On a day with a big pullback, you are trading a lower premium for the
potential capital gain of the bounce back price. For example, a stock is
trading at $45 and the current month 45 call is priced at $2.10 indicating a
cost basis of $42.90 and an assigned return of 4.9%. However, on the
market down-day, the stock drops to $43 and the 45 call price drops to
$0.90. If you enter this trade by buying the stock at $43 and selling the 45
call for $0.90, your cost basis is now $42.10 and your assigned return is now
6.9%. If the stock falls short of $45 at expiration, you keep the $0.90 in
premium and write a new 45 call at the next expiration date.

The key to this strategy is making sure the stock is trading with the market.
Here we will define the market as the S&P 500. Use a chart service such as
bigcharts to create a chart with your stock. Then click the compare bottom
to add the SPX (S&P 500). You should notice that the stock and SPX have a
very similar pattern. If yes, the two are moving in lockstep together and this
is a good candidate for this strategy.

This strategy is not about the technical movement of the charts but about
the potential snap back movement of the stock. This serves as an example

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of why covered call traders sell out-of-the-money (OTM) calls to increase
return on investments.


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Covered Calls at Expiration

There are many variations of the covered call trade. The classic covered call
is to select the trade, buy the stock and sell the ATM call. In addition, there
are a number of strategies that are variations of the classic call based on
different trading ideas. One variation is expiration writing.

The investor will scan for short-term writes in the last two weeks of the
current option cycle. The trader is looking for stocks with high premium and
high return on funds invested. To get high returns over such a short time
period usually indicates a high implied volatility and increased risk. When IV
is higher than actual volatility, then there is usually a pending event so you
must research these trades very thoroughly.

One safer way to do this is to find a stock with higher volatility due to an
event planned in advance. Examine the stock to see when the event date is
scheduled. If the event will occur after the current expiration date, then you
can trade in the current month calls. The reason for this is that event
volatility may increase premiums across both the current month and the
next month option cycles. This is a cool trick that most covered call writers
had not heard of before.

This is not a risk free trade but it works if you are right about the timing of
the event expiration being after the current month. The key is to actually
confirm the event date and not speculating about when it will occur. Do not
just go by the high volatility in two month alone. If the IV is in line with the
historical volatility, it may be a great covered call write anyway.


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Disclaimer:
This Special Report is published by G3 Marketers LLC, which operates the famed
Get Rich – Stay Rich: Investing For monthly Income brand and
getrichinvestments.com website and publishes the get Rich Monthly Income
Newsletter. Neither the author, G3 Marketers LLC, Get Rich Newsletter nor
any person associated with them is a broker or investment adviser, nor is any of
them a professional securities analyst; and none of them recommends the
purchase, sale or holding of any security. Your use of any information or strategy
appearing in this book, in the Get Rich NEWSLETTER or on getrichinvestments.com
is solely at your own risk.

We urge you to do all requisite analysis and properly plan each trade prior to
placing any trade and to manage each open trade effectively. Trading stocks and
stock options involves risks, and no strategy can eliminate them entirely. Moreover,
poor trading decisions, frequently the result of greed or panic, are responsible for
many losses in covered call writing, and only you can prevent them. Neither the
author, Get Rich Newsletter, getrichinvestments.com nor any person associated
with them will be liable to any person for any losses or damages, whatsoever,
monetary or otherwise, alleged to arise from the content of Get Rich newsletter,
any Special Report or the use of any strategy or information discussed on
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© 2011, G3 Marketers LLC. All rights reserved. Unauthorized reproduction is strictly
prohibited. Information is based on best available resources. Opinions reflect judgment
at the time and are subject to change.

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