# Complete Guide to the Covered Call: From Start to Finish



## Kunal of HSM (21 September 2010)

*An Introduction: Clearing the foggy idea around the covered call.*

The ‘pitter-patter’ of the raindrops hitting the window sill as I type this sentence can’t even stop me from clearing the dark clouds surrounding the misconception of the covered call stock option strategy.

In my experience as a stock market option investor, and as a true enthusiast and student of stock market investing, the covered call is probably the most underestimated option strategy. Granted, it is probably the most well known stock option strategy – partly because it is often taught in introductory stock option courses to beginner investors. 

Unfortunately, it’s true potential is also overlooked, as many beginner investors are quick to dump the simple covered call to get in bed with the sexier stock option strategies that many websites often pump-up. But then, what is really that sexy about a strategy that can be repeatable, scalable, and often profitable (if done right)? Who wants that anyways?

I will keep this thread as an on-going conversation as I provide details of my own covered call experiences, conversations I have with other well-known covered call enthusiasts, and to dispel misconceptions that many beginner investors have with the covered call strategy.

*Part 1.0: The most common way to use covered calls (and why it sucks)*

You know what? The covered call does suck. There, I said it. The reason being is that the way it is taught sucks, and the target audience who is learning this strategy is left with the sucky-results. Then, they get discouraged, trash-talk the whole covered call strategy, eagerly wanting to forget the experience in hopes of learning more advanced option topics, go through the school of hard knocks of losing more money, and then look to re-learn the basics of option trading, which should have been taught to them, correctly, from the beginning.

The way most beginners are taught to think about the covered call strategy is to think of it in terms of getting monthly rental payments as a real estate landlord – a nice fat cheque paid on every month, on time. While there is a lot of truth in this analogy, as that really is the best way to describe the covered call method in a plain-vanilla, relatable, down-to-earth manner, this explanation leaves a LOT of information out. I can name two exclusions just off the top of my head:

1.	A covered call CAPS your gains. Do you remember the reason why you bought your shares in the first place? I’m guessing it’s because you actually LIKE the company. So why would you shoot yourself in the foot by capping the gains, just to make monthly income which could be just a fraction of potential gains that you miss out (and really, should be entitled to) if your stock goes through a high momentum bull run? 

2.	The covered call SHOULD NOT be your number one choice of protecting your portfolio: I laugh. No, I literally laugh when I read how people use covered calls to “protect” their portfolios. Yes, there are ways to use the covered calls as hedges, but the way most people are taught to sell covered calls (out of the money strikes, at best, at the money strikes) is a pathetic excuse of a hedging tactic. 

Let’s just get technical for a second. Whenever you sell a covered call option, you must own at least 100 shares, right? 100 shares = ability to sell 1 call option. For this example, we’ll assume you have 100 shares of a stock that we’ll call, “HelloStockMarket”, just for kicks. 

Rule of thumb: the at-the-money front month call option has a delta of 0.50.

You own 100 shares, each share has a delta of 0.01, so owning 100 shares gives you 1.00

Doing the quick math, you’ll notice you leave your stock portfolio exposed 0.50. This is NOT an efficient hedge! 

And this, usually, is the best case scenario, as most covered call books teach you to sell out-of-the-money call strikes (so that you can get that time value depreciation). 

So, you’re thinking, “Kunal, then, what is the solution?”

Coming in Part 2.0! Stay tuned. By the way, I will try to update this thread twice a week, but because I work a fulltime job, it may be once a week. So maybe bookmark it if you would like.

Also, leave a comment if something is unclear. I’m trying to make this the most awesome covered call thread available online. I love this stuff! Stock option investing is my passion!

Thanks everyone,
Kunal


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## wayneL (21 September 2010)

Kunal of HSM said:


> Let’s just get technical for a second. Whenever you sell a covered call option, you must own at least 100 shares, right? 100 shares = ability to sell 1 call option. Rule of thumb: the at-the-money front month call option has a delta of 0.50.
> 
> You own 100 shares, each share has a delta of 0.01, so owning 100 shares gives you 1.00




Just tidying up some details:

Delta is expressed as a fraction of a whole number. Long shares have a delta of 1, owning 100 shares gives you 100 deltas.

ATM call options have a delta of ~0.5, a contract of 100 gives you ~50 deltas. But that only applies to the long call. Short calls have negative deltas so -0.5 and -50.

100 + -50 = 50 deltas when atm. This means that (if considering current delta only) the combined strategy (100 shares plus sold call contract) will change value as if you owned 50 long shares.


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## Kunal of HSM (22 September 2010)

Thanks Wayne, 

For some reason I'm not getting notified when comments are posted, otherwise I would have answered sooner.

I'll take a bit more care in upcoming additions to this thread. 

If anyone out there is reading this thread, and if something is unclear, please post - I'll incorporate as I continue adding.

Thanks a lot for the comments, and feedback!

Kunal


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## ENP (22 September 2010)

Yea I'm a bit unclear about the whole delta thing. Short/long, positive/negative etc.

And I've heard of people putting in options as "insurance" too incase the stock plummets in price within the month?

Disclaimer... I know little about covered calls.


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## breaker (22 September 2010)

Thanks Kunal

I am interested in covered calls but find it all abit perplexing 

Maybe you could use a stock example and place a step by step call on it

Thanks


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## wayneL (24 September 2010)

One of the mods deleted some spam from this thread. For those spared the unmitigated drivel, here is an example of the fuzzy thinking common in CC spam



> Nakedness - Not On This Site!
> It is worth mentioning that there is another kind of option called "naked".
> A naked option is one where you have sold (shorted) the option but do not own an offsetting position of the underlying stock.
> Selling naked options is extremely risky and represents potentially unlimited liability to the seller. It is more like gambling than investing and is the OPPOSITE of what covered call writers do. We do not encourage or recommend running with scissors or naked option writing; you could get seriously hurt!




I hope by now that ASF members understand synthetic relationships. With reference to covered calls, this strategy is simply a synthetic short put.

Understanding this makes one realize the above statement is straight out of One Flew Over The Cuckoos nest.

If shorting a put is running with scissors, it is then logical, _ipso facto_ a covered call is also running with scissors as they have the identical payoff diagram (if of the same strike and expiry).

Covered call good and conservative- naked put bad and risky??

Just some clown reading male bovine excrement and vomiting it all up again... AND asking to be paid for it.


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## Cakeman (25 September 2010)

Hi, is the minimum contract size 1000? I notice in your write up you use an example with 100 shares. 

I would like to write covered calls/puts however i dont own 1000's of one stock just hundreds.

On the asx websites and commsec websites they say minimum contract size is 1000.

Any info would be great.

cheers


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## wayneL (25 September 2010)

Cakeman said:


> Hi, is the minimum contract size 1000? I notice in your write up you use an example with 100 shares.
> 
> I would like to write covered calls/puts however i dont own 1000's of one stock just hundreds.
> 
> ...




In OZ the standard contract size is 1000. In the US it's 100.


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## skc (27 September 2010)

wayneL said:


> One of the mods deleted some spam from this thread. For those spared the unmitigated drivel, here is an example of the fuzzy thinking common in CC spam
> 
> 
> 
> ...




So is it true that naked puts will always outperform CC due to the lower transaction and holding costs?

I suppose if you hold the share already and wouldn't mind picking up a few premium than CC is the way to go (when done correctly), but buying shares specifically for the sole purpose of writing CC would be an inefficient way to deploy capital?


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## village idiot (5 October 2010)

cmon kunal where is the report we were promised??


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## wayneL (5 October 2010)

village idiot said:


> cmon kunal where is the report we were promised??




We must have scared him off 



> Last Activity: 22nd-September-2010 02:36 PM


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## village idiot (13 October 2010)

kunal's first monthly report - 


http://www.hellostockmarket.com/bamboo-strategy-september-2010-progress-report/


he sold a call spread but forgot to check when it went xd, so he had to buy it back in a hurry when he remembered. lolol.


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## wayneL (14 October 2010)

1/ I hate it when they don't mention strike prices net debit/credit etc.

2/ I hate it when people promote covered calls, do something different and still lump it under covered calls  The strategy kunal used is a synthetic semistock. It is no longer a covered call.

3/ The local muppets do the same thing - "share renting with insurance" is just called a collar you dopey turds. I hate that too. 

Maybe I'm just a pedant LOL


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## mazzatelli (14 October 2010)

wayneL said:


> Maybe I'm just a pedant LOL




The truth is you are one grumpy geezer :


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## wayneL (14 October 2010)

mazzatelli said:


> The truth is you are one grumpy geezer :




Well... it's been raining all week here. A perfect excuse for grumpiness.


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## noirua (19 October 2010)

wayneL said:


> Well... it's been raining all week here. A perfect excuse for grumpiness.




An excellent thread. All must take a very small break and make their way over to: http://www.thebull.com.au/the_stockies/forums.html

The main extravaganza will open very shortly but ASF would much appreciate your support, thank you so very much and very good fortune with your 'covered calls'.


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