This long-term covered call position is ideal for mature stocks with upside potential, writes Jay So...
Starbucks Covered Calls
05/15/2019 9:59 am EST
Covered calls are a solid approach to trading as revealed by Jay Soloff.
Greetings from the Las Vegas MoneyShow! This event is always one of my favorites to speak at every year. It’s a great place to meet with other options traders or traders who are looking to learn how to start using options.
This year I’m presenting primarily about overwriting (selling options in conjunction with owning stocks) and volatility trading. Overwriting may be the most powerful use of options available to traders and investors.
Options overwriting takes two forms: Covered calls and cash-secured puts. Covered calls involve buying stock and selling calls against the shares (at the same time) to generate income while still allowing for price appreciation in the stock. Cash-secured puts utilizes selling puts (fully secured by available cash) to generate income and potentially set a more attractive entry point to buy shares.
Covered calls are bit more intuitive to new options traders than cash-secured puts. Owing the stock allows you to make money if the stock goes up and still collect a dividend if there is one. Selling a call against the shares provides income in return for capping the growth potential of the stock.
What makes covered calls so attractive is how low risk they are. The strategy is actually less risky than owning stock by itself because of the additional cushion you get by collecting income from the calls. Meanwhile, you can earn a monthly return akin to a dividend, but often times with a much higher yield. Plus, there is often still room for the stock price to appreciate.
Let’s look at a real example which just came across my trading screen.
A covered call trader purchased 100,000 shares of Starbucks (SBUX) while selling 1,000 June 21 calls against those shares. The stock was trading at $77.75 at the time, and the calls were at the 80 strike and sold for $1.00 in premium.
Breaking this trade down, the $1.00 received for selling the calls means the trader is protected down to $76.75 in the stock. That dollar also represents a 1.3% yield in under six weeks (annualized it would be 11.3%). At the same time, the position still earns $2.25 in share price upside before being capped (2.9%).
All told, the trade can earn 4.2% max gain in under six weeks. At the same time, the shares are protected down to $76.75 during that period. It’s easy to see why these trades are so popular. Generate additional income, keep some upside potential and protect some of your downside risk all in one trade.
Looking at the chart, you can see why SBUX makes for a good covered call candidate. The market turmoil this past week hasn’t caused the share price to dip. Meanwhile, the climb in the stock price has been slow and steady. These are nearly ideal conditions for this type of trade.
Of course, there’s no reason you can’t make this exact same trade in your own account. Moreover, it’s as simple matter to adjust the strike or expiration of the call to suit your personal trading style or income expectations.
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