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 100 shares of a stock yet and you don’t want to pay full price for it? This is where the In-the-Money Covered Call strategy comes into play. This strategy gives you the ability to purchase stocks at a discounted price.
👉 Click here to review Terminology
📊 Options: These are contracts that let you buy or sell a stock at a set price. Think of them like coupons for stocks that you can use before they expire. Each option costs a certain amount (called the premium) and represents 100 shares of the stock.
⬆️ Call Options: A way to bet on a stock you think will go up in price. They give you the right to buy the stock at a set price (called the strike price). For example, if your contract lets you buy the stock for $10, and the stock later rises to $20, both the stock and your call option increase in value — meaning your option becomes more profitable.
⬇️ Put Options: A way to bet on a stock you think will go down in price. They give you the right to sell the stock at a set price. For example, if your contract lets you sell the stock for $10 and the stock later drops to $5, the stock’s value decreases, but your put option becomes more valuable — since you can still sell it for $10, your option gains profit as the stock falls.
💲Strike Price: This is the set price at which you can buy or sell the stock when using an option.
Exercised: An action the buyer takes after options contract expire.
- For Call Options: Exercising a call option means you buy the stock at the strike price (even if the market price is higher).
- For Put Options: Exercising a put option means you sell the stock at the strike price (even if the market price is lower).
Assigned: An action the seller takes after options contract expire. You are obligated to purchase the shares at the set strike price (more on this in Level 3).
𝚫 Delta: is a number that shows how much an option’s price is expected to move for every $1 change in the underlying stock’s price.
- For call options, delta ranges from 0 to 1. A delta of 0.50 means the option price will roughly move 50 cents for every $1 the stock moves up.
- For put options, delta ranges from 0 to -1. A delta of -0.50 means the option price will roughly move 50 cents for every $1 the stock moves down.
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 when your goal is to purchase at a discount.
** This strategy can be done within TFSA and RRSP accounts for tax saving purposes.
Below are the steps to initiate this trade. In the example, we are going to use AAPL or Apple, which is currently being worth $269/share (rounded for simplicity).
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 $269/share = $26,900
2. Sell 1 ITM Call Contract
Choose an expiration date about 30–45 days out. On the Call side of the options chain, select a strike price that’s lower than the price you paid for your 100 Apple shares. The deeper the option is in the money (ITM), the higher its premium will be. I prefer strike prices ending in 0 or 5, as they typically offer better liquidity and tighter spreads. In this example, we’ll use the $250 strike price.
See the video below on how it’s done:
Looking at the options chain above, the $250 Call option expiring in 39 days is priced between $22.60 and $22.75. To place this trade, click on the Bid price to sell one contract at $22.60.
You now own 100 shares of AAPL for less than what it’s currently worth. Here’s the math:
You purchased 100 shares for $26,900
You sold 1 call option and collected $22.60 x 100 (shares) = $2260
Your Actual Cost: $26,900 – $2260 = $24,640 (Which is equivalent to $246.40/share)
3. WHAT HAPPENS ON EXPIRATION DAY?
If the stock rises above…
If the stock price stays above your Call option’s strike price when it expires, the option will be exercised. This means you’ll have to sell your 100 shares at that strike price. You still keep the money you earned from selling the option, plus you’ll make extra profit from the difference between what you paid for the shares and the strike price.
Here’s the math:
Apple’s stock rises to $270 on expiration day, which is well above your $250 Call option strike price. As a result, you’ll be required to sell your 100 shares at $250 each. Since you originally bought them at $246.40/per share, so you’ll still make a small profit.
$250(option strike price) – $246.60(your actual purchase price) = $3.40 gain
Final total: $3.40 gain x 100 shares = $340
You have now earned $340 from this trade! Repeat Step 1 on the following week.
If the stock drops below…
If the stock falls below your Call option’s strike price, you keep your 100 shares. You can then sell an out-of-the-money covered call, picking a strike price above your purchase actual purchase price and an expiration 30–45 days out.
See Investment Plan: Level 1 to review steps for Covered Calls.
HOW MUCH CAN YOU POTENTIALLY EARN FROM THIS STRATEGY?
- Selling 1 Call Option @ $3.40 = $340/mo.
- Selling 5 Call Options @ $3.40 = $1700/mo.
- Selling 10 Call Options @ $3.40 = $3400/mo.
Helpful Tips:
- Only trade this strategy 1-2 times per month to avoid getting taxed as a self-employed business
- Avoid choosing expiration dates that contain dividend payout days, your shares could be exercised earlier and you’ll miss out on the dividend payout.
- Avoid choosing expiration dates that coincide with earnings reports or product release events for the stock. Anything can happen—prices could swing up or down significantly.
- Trade ETFs when possible where no single news events would have a big impact on the share price.
- This strategy works best in markets that are trending upwards or sideways.
-The Wealthy Sheep 👩🏻💻