IN-THE-MONEY COVERED CALL
In our Investment Plan: Level 1, we discussed purchasing 100 shares of a stock in order to start the Covered Call strategy, however, what if you don’t own the stock yet and you don’t want to pay full price for it? This is where the In-the-Money Covered Call comes into play. This strategy gives investors the ability to purchase stocks at a discounted price.
When a Call Option contract is In-the-Money (ITM) it means the current share price is greater than the contract’s strike price. This will work in your favour. The opposite is true for Put options.
** This strategy can be done within TFSA and RRSP accounts.
See the steps below to on how it’s done:
In this example, we are going to use AAPL or Apple, which is currently being worth $148/share.
1. Buy 100 Shares of a Stock
Just like in Investment Plan: Level 1, you need to first purchase 100 shares of a stock to start this strategy. In this scenario we will buy 100 shares of AAPL.
100 x AAPL $148/share = $14,800
2. Sell 1 ITM Call Contract
Choose a date that’s about 30-45 days from today. Then go to the Call side of the options chain and choose a strike price that’s less than what you paid for those 100 shares of stock.
In this example, we are looking at the options chain of January 6, 2023 which is 35 days until expiration. The Call options are on the left side, all the options highlighted in green are the options that are considered ITM, or less than what the current stock price is. The further in ITM, the more valuable that option becomes. I like to choose strike prices ending in 0 or 5, they typically have more volume and better pricing.
Looking at the options chain above, the Call options at strike price of $145 expiring 35 days from now is valued between $7.75-$8.05. To initiate this trade, click on the Bid Price to sell 1 contract for $7.75. Since you own 100 shares, the total premium collected will be $7.75 x 100 shares = $775.
You now own 100 shares of AAPL for less than what it’s currently worth. Here’s the math:
You purchased 100 shares for $14,800
You sold 1 call option and collected $775
Your Actual Purchase Price: $14,800 – $775 = $14,025 (Which is equivalent to $140.25/share)
3. WHAT HAPPENS ON EXPIRATION DAY?
If the stock rises above…
If the stock rises above your Call Option strike price, then you must sell 100 shares for the strike price you chose. This action is also called being “exercised.” But remember, you purchased these shares for a discounted price, so you will have a net gain after the trade expires.
Here’s the math:
Apple is now trading for $148 which is well above the $145 call option strike price. You must sell your 100 shares for $145 each, but remember you purchased the stock at a discounted price of $140.25/share.
$145(option strike price) – $140.25(your actual purchase price) = $4.75 gain
Final total: $4.75 gain x 100 shares = $475
You have now earned $475 from this trade! Repeat Step 1 on the following week.
If the stock drops below…
If the stock drops below your Call Option strike price, then you keep the 100 shares of the stock and begin selling Covered Calls. Choose a strike price that’s above your cost per share with 30-45 days until expiration. Continue this step until your shares are exercised, then Repeat Step 1.
For example:
Your actual purchase price of AAPL was $140.25. So you must choose a call option strike price that’s greater than $140.25 like $145 or $150 strike. Click the link below for more details on how to make this trade.
See Investment Plan: Level 1 to review steps for Covered Calls.
HOW MUCH CAN YOU POTENTIALLY EARN FROM THIS STRATEGY?
- Selling 1 Call Option @ $4.75 = $475/mo.
- Selling 5 Call Options @ $4.75 = $2375/mo.
- Selling 10 Call Options @ $4.75 = $4750/mo.
Success Tips:
- Only trade this strategy 1-2 times per month to avoid getting flagged by the CRA.
- Avoid choosing expiration dates that contain dividend payout days, your shares could be exercised earlier and you’ll lose the dividend payout.
- Avoid choosing expiration dates that contain earnings events. Anything can happen, the stock could swing up or down significantly which could affect your profits.
- This strategy works best in markets that are upwards or sideways trending.
-The Wealthy Sheep