Covered call strategy in options trading: 18 January 2022

Blog | TRADING 101

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:

India’s largest private bank’s net profit beat street estimates and rose 18% year-on-year to ₹10,342 crore in the December quarter. The double digit growth in the bottom line was aided by a 13% rise in the net interest income to ₹18,443 crore. 

Its current account savings account deposits grew by 24.6% taking the CASA deposits to 47.1% of the total deposits as on December 31. 

Derivatives Build-up:

After a strong run-up to highs of ₹1572 earlier this month, the stock had corrected nearly 3% to 1519 levels. The stock has now bounced back to ₹1525 levels. 

The January options data of HDFC Bank shows a significant open interest base for call options at 1,560 strike, which is nearly 3% higher than the current price of 1,525, suggesting that the stock might face resistance at that price 

The lot size in the F&O contract is 550 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 January futures expiry at the price of ₹1,525 then one can sell 1 lot of  1,560 call option (OTM call) of the January expiry at a premium of ₹10.

Now, on expiry, if the stock moves higher and closes at, say ₹1,560 levels, the trader will make a total profit of ₹24,750 (Profit on Long Futures: (35 * 550 = ₹19,250) + Profit on Short Call Options: (10 * 550 = ₹5,500).

However, at the price of ₹1,560, the profit is capped at ₹24,750 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 ₹1,515 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 ₹1,515, the trader will incur a loss on the Futures position but it will still be ₹10 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 ₹1,525 one will still make a profit of ₹5,500 (10 * 550) 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.


If you haven't already done so, activate the F&O segment on your Upstox account! Click here to begin F&O trading.

Here is a detailed guide on how to activate your commodities/futures/options segments on Upstox. Click here to know more.  


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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