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
Deepak Nitrite, the prominent chemical manufacturing company, posted a mixed set of numbers for Q2 FY22. The management announced its plans to continue adding new products under the fine and speciality segment and bridging the gaps.
Management also reiterated its increased focus towards high-value products that would aid margin expansion.
In its recent filing to the exchange, the company said that its board is considering raising funds via the issue of equity shares or any other instruments and securities.
Derivatives Build-up
After a strong run-up to highs of ₹2,405 last month, the stock had corrected nearly 17% to ₹2,005 levels. The stock has now bounced back to ₹2,351 levels.
The December options data of Deepak Nitrite shows a significant open interest base for call options at 2,400 strike, which is nearly 2% higher than the current price of ₹2,351, suggesting that the stock might face resistance at that price
The lot size of Deepak Nitrite 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 December futures expiry at the price of ₹2,351, you can sell 1 lot of 2,400 call option (OTM call) of the December expiry at a premium of ₹54.
Now, on expiry, if the stock moves higher and closes at, say ₹2,400 levels, the trader will make a total profit of ₹25,750 (Profit on long futures: (49 * 250 = ₹12,250) + profit on short call options: (54 * 250 = ₹13,500).
However, at the price of ₹2,454, the profit is capped at ₹25,750 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 ₹2,297 levels, the trader will not incur a loss because even though the futures position will incur loss, the call option position will cover that loss. This is the break-even point for the strategy.
Below ₹2,297, the trader will incur a loss on the Futures position, but it will still be ₹54 less than what they would have incurred had they not sold the call option.
Even if the stock expires at the futures buying price of ₹2,351, the trader will still make profit of ₹13,500 (54 * 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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