20 October 2021: Covered call strategy in options trading

A covered call strategy works as a hedge for short to medium-term trading. This strategy can be employed by traders who wish to hold the stock in Futures and minimise the risk by selling its call option.

Let’s see how this works.

Background:

1. The realty sector has seen robust demand across all segments. The Nifty Realty index is up more than 30% since August and Can Fin Homes is a leading player in the housing finance space.
2. Can Fin Homes has a strong ability to tap high credit quality clients, robust asset quality and is able to manage its credit costs better.
3. With the demand for homes picking up, the company is poised for healthy loan growth and higher margins going forward.

Derivatives Build-up:

1. After a strong run-up to highs of ₹722, the stock has corrected nearly 6% to ₹680 levels.
2. The options data of Can Fin Homes shows a significant open interest base for call options at 700 strike, which is nearly 3% higher than the current price of ₹680, suggesting that the stock might face resistance at that price
3. The lot size in the F&O contract is 975 shares per lot.

Action:

1. Traders who are willing to take a short to medium-term bullish position tend to initiate a covered call strategy that combines both futures and options positions.
2. For instance, if you buy 1 lot of the October futures series at the price of ₹680, one can sell 1 lot of 700 call option of the current series at a premium of ₹25.
3. Now, on expiry, if the stock moves higher to say ₹700 levels, the trader will make a profit ₹43,875 (Profit on Long Futures: (20*975 = 19,500) + Profit on Short Call Options: (25*975 = 24,375).
4. However, at the price of ₹725, the profit is capped 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..
5. But in case the stock goes down, say to ₹655 levels, the trader will not incur loss because even though the futures position will be in loss the options position will help reduce that loss.
6. Below ₹655, the trader will incur a loss but it will still be ₹25 less than what they would have incurred without the hedge.
7. In fact, even if the stock expires at the futures buying price of ₹680 one will still make a profit of ₹24,375 (25*975) on the short call position.

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.