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
Axis Bank posted robust results for Q3 FY22 with a 224% jump in standalone net profit at ₹3,614 crore on strong growth across deposits and loans, improving asset quality.
The bank’s net interest income (NII) grew 17% YoY to Rs 8,653 crore. Net interest margin (NIM) for Q3FY22 improved by 14 bps QoQ to 3.53%.
The company said they plan to focus on digital strategy, are optimistic about the future, and plan to leverage every sustainable growth opportunity.
Derivatives Build-up
After a strong run-up to highs of ₹755 earlier this month, the stock had corrected nearly 8% to ₹691 levels. The stock has now bounced back to ₹750 levels.
The February options data of Axis Bank shows a significant open interest base for call options at 780 strike, which is nearly 4% higher than the current price of ₹750, suggesting that the stock might face resistance at that price
The lot size in the F&O contract is 1,200 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 February futures expiry at the price of ₹750 then one can sell 1 lot of 780 call option (OTM call) of the February expiry at a premium of ₹15.
Now, on expiry, if the stock moves higher and closes at, say ₹780 levels, the trader will make a total profit of ₹54,000 (Profit on Long Futures: (30 * 1,200 = ₹36,000) + Profit on Short Call Options: (15 * 1,200 = ₹18,000).
However, at the price of ₹795, the profit is capped at ₹54,000 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 ₹735 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 this strategy.
Below ₹735, the trader will incur a loss on the Futures position but it will still be ₹15 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 ₹750 one will still make a profit of ₹18,000 (15 * 1,200) on the short call position.
To know the margin required to execute this strategy, you can click on this link: 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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