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
Birlasoft (Bsoft) is a part of the multi-billion dollar diversified CK Birla Group and combines the power of domain, enterprise, and digital technologies to reimagine business processes for customers and their ecosystem.
For Q2 FY22, Birlasoft posted a robust set of numbers with a year-on-year 18% jump in its revenue and 49.2% jump in profit-after-tax. The company also reported big deal wins in the last quarter as cross-selling picked up across its key clients in the US and Europe.
Derivatives Build-up
After a strong run-up to highs of ₹515 last month, the stock had corrected nearly 8% to ₹450 levels. The stock has now bounced back to ₹488 levels.
The December options data of Bsoft shows a significant open interest base for call options at 500 strike, which is nearly 2% higher than the current price of ₹488, suggesting that the stock might face resistance at that price
The lot size of the stock in the F&O contract is 1,300 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 initiate a buy order of 1 lot of the December futures expiry at the price of ₹488 then one can sell 1 lot of 500 call option (OTM call) of the December expiry at a premium of ₹17.
Now, on expiry, if the stock moves higher and closes at, say ₹500 levels, the trader will make a total profit of ₹37,700 (Profit on Long Futures: (12 * 1,300 = ₹15,600) + Profit on Short Call Options: (17 * 1,300 = ₹22,100).
However, at the price of ₹517, the profit is capped at ₹37,700 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 ₹471 levels, the trader will not incur loss because even though the futures position will incur loss but the call option position will cover that loss. This is the break-even point for the strategy.
Below ₹471, the trader will incur a loss on the Futures position but it will still be ₹17 less than what they would have incurred had they not sold the call option.
In fact, even if the stock expires at the futures buying price of ₹488 one will still make a profit of ₹22,100 (17 * 1,300) 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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