A covered call strategy in options works as a hedge for short to medium-term trading. This strategy can be deployed by traders who wish to hold the stock in futures and minimise the risk by selling its call option.
Let’s understand how this strategy works.
Background
Pidilite is the market leader in adhesives and has an ever-evolving product portfolio, from adhesives, sealants, waterproofing solutions and construction chemicals to arts & crafts, industrial resins, polymers and more.
The company’s revenue from operations during the Q3FY21 jumped 24 % to ₹2,850 crore. However, due to high input costs, its net profit declined 19.5% to ₹359 crore.
After the recent correction, the stock has bounced back and closed above its 200 days moving average (DMA).
Derivatives Build-up
After a solid run-up to ₹2,492 last month, the stock had corrected nearly 14% to ₹2,140 levels. It has now bounced back to ₹2,340 levels.
The March options data of Pidilite shows a significant open interest base for call options at 2,400 strike, which is nearly 3% higher than the current price of ₹2,340, suggesting that the stock might face resistance at that price.
The lot size in the F&O contract is 250 shares per lot.
Action
Traders who are willing to take a neutral to moderately bullish position tend to initiate a covered call strategy that combines both futures and options positions.
For instance, if you buy 1 lot of the March futures expiry at the price of ₹2,340 then one can sell 1 lot of 2,400 call option (OTM call) of the March expiry at a premium of ₹40.
Now, on expiry, if the stock moves higher and closes at, say ₹2,400 levels, the trader will make a total profit of ₹25,000 (Profit on Long Futures: (60 * 250 = ₹15,000) + Profit on Short Call Options: (40 * 250 = ₹10,000).
However, at the price of ₹2,440, the profit is capped at ₹25,000 because above this rate, every one rupee profit in long futures position will be offset by a one rupee loss in short call option position.
But in case the stock goes down, say to ₹2,300 levels, the trader will not incur a loss because even though the futures position will incur a loss, the call option position will cover that loss. This is the break-even point for the strategy.
Below ₹2,300, the trader will incur a loss on the Futures position, but it will still be ₹40 less than they would have incurred had they not sold the call option.
In fact, even if the stock expires at the futures buying price of ₹2,340 one will still make a profit of ₹10,000 (40 * 250) on the short call position.
To know the margin required to execute this strategy, you can click on this link: https://upstox.com/calculator/span-calculator/
We hope this strategy was simple and easy to understand. You can try spotting it on the option chain and see if you are able to identify levels.
We’ll be coming with a lot of strategies which will help you to identify trade setups easily.
Until then, happy trading!
About the author: Kush Bohra is a SEBI-registered investment advisor and an F&O expert.
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Disclaimer
Derivatives trading must be done only by traders who fully understand the risks associated with them and strictly apply risk mechanisms like stop-losses.
We do not recommend any particular stock. The stock names mentioned in this article are purely for showing how to do analysis. Take your own decision before investing.
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