Covered call strategy in options trading: 4 February 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:

Cholamandalam Investments' net profit rose 28% to ₹524 crore in Q3FY22. The company's loan book expanded by 32% to ₹10,430 crore.

The management said that the uptrend in tax collections and healthy demand during festive seasons boosting auto sales improved demand for mortgage loans.

Derivatives Build-up:

After a strong run-up to highs of ₹672 last month, the stock had corrected nearly 7% to 622 levels. The stock has now bounced back to ₹670 levels. 

The February options data of CholaFin shows a significant open interest base for call options at 700 strike, which is nearly 4% higher than the current price of ₹670, suggesting that the stock might face resistance at that price 

The lot size in the F&O contract is 1,250 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 February futures expiry at the price of ₹670 then one can sell 1 lot of  700 call option (OTM call) of the February monthly expiry at a premium of ₹15.

Now, on expiry, if the stock moves higher and closes at, say ₹700 levels, the trader will make a total profit of ₹56,250 (Profit on Long Futures: (30 * 1,250 = ₹37,500) + Profit on Short Call Options: (15 * 1,250 = ₹18,750).

However, at the price of ₹715, the profit is capped at ₹56,250 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 ₹655 levels, the trader will not incur a loss because even though the futures position will incur a loss, the call option position will offset that loss. This is the break-even point for the strategy. 

Below ₹655, the trader will incur a loss on the Futures position, but it will be ₹15 less than they would have incurred had they not sold the call option.

In fact, even if the stock expires at the futures buying price of ₹670, one will still make a profit of ₹18,750 (15*1,250) 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.


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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