Covered Call

Covered Call is an option trading strategy used by traders to protect their share holdings. Using this strategy, one can get a small income every month or protect their capital from huge fall.

Example 1:

Suppose you are holding 550 quantities of HDFC Bank shares, which is trading at ₹1100 in Jul’20. You are bullish on your holdings but are also worried about the downside i.e. losses if there is a sharp fall and share goes below 900 then your loss will be more.

In that situation, you can do a Covered Call option strategy.

It can be initiated by selling an OTM (out of money) 1300 Call for a premium of ₹1 to 2 and buying 900 Put for ₹1 to 2.

1.    Sell an out of money Call at 1300 (₹1-2)

2.    Buy an out of money Put at 900 (₹1-2)

 Therefore, you are getting credit from the call side that can be used for the put side.

Scenario 1,

If HDFC Bank shares do not go above 1300 nor below 900, you do not have to do anything. If the share price is in the upper side for example 1200 then you can sell the shares and book profit. Otherwise, you can hold the shares for further up-movement.

Scenario 2,

If HDFC Bank shares go above 1300 then you can give the delivery of the shares to the call option sold. Let us assume share closed at 1300

Share profit -> (Expiration price - Buy price) * Lot size

                      (1300 – 1100) * 550 -> 1,10,000 (1 Lakh, 10 thousand)

Scenario 3,

If HDFC Bank shares close below 900 you have two choices to make,

1.    You can book the loss of 200 * 550 -> 1,10,000 (1 Lakh, 10 thousand)

2.    If you feel share price will go up in the near future and you don’t want to sell it in loss then you can square of the put options and take the profit, if any

Profit / Loss based on HDFC Bank Expiration closed price

1.    HDFC Bank shares bought at 1100

2.    1300 Call sold at 2

3.    900 Put bought at 2

HDFC Bank expiration price	Stock P/L	Call P/L	Put P/L	Total P/L
1200	100	2	-2	100 * 550 = 55,000
1300	200	2	-2	200 * 550 = 1,10,000
900	-200	2	-2	-200 * 550 = -1,10,000
1500	400	-198	-2	200 * 550 = 1,10,000
700	-400	2	198	-200 * 550 = 1,10,000

 Other important points?

• How to exit the positions manually?

• Do I need to pay any margin for creating this strategy?

• With small changes in the above strategy can get you 6-12% return every year from covered call

Watch our video link below to know more about the covered call strategy and for other key points. 

Video Link (Tamil) - https://www.youtube.com/watch?v=rPyQyvns46Q