There are numerous ways of calculating returns on option investments but there are two primary ways of calculating returns on covered calls. These include the trade’s flat return – assuming the stock is unchanged until expiration, and the if-called return – assuming that assignment takes place and the underlying stock is called away. The formula used to compute the flat CC return is to take the net call premium, which is the time value portion of the option’s premium, and divide it by the cost to put on the trade (net debit, which is stock price minus the option premium).
Many investors purchase and maintain stock in hope that these shares will go up in cost. An alternative strategy that can help investors attain more gain while also lessening downside risk is the writing of covered calls on those shares. The advantage of covered calls over the buy and hold strategy is that CCs allow investors to receive income from those shares, in addition to getting dividends (if offered), while they hold the stock.
Using covered calls pays the investor downside protection while also permitting them to make money if their stock prices go up, stay flat, even if the price of the stock goes down a little bit . As an example, an investor owns 100 shares of XYZ Company that were bought at $60 per share. The investor decides to write a call on these shares with a strike price of $65. He is paid $2 per share in option premium, meaning that the investor gets $200 today. If the price of the XYZ Company shares goes up, the investor will get gains because he not only maintain the $200 option premium, but he also deal his stock for $5 per share more than he purchased it for.
If the price of the stock remains flat, the investor will still get profit. This is because, although he did not traded his stock, he allows to keep the $200 option premium that he received for writing the call .
The investor can even get profit if the share price goes down a little. In this case, the investor would profit if the share price of XYZ Company went down less than $2 per share. This, too, is because the investor was allowed to keep the $200 option premium received. If the investor is not obligated to trade his shares, he can write another call option on those same shares once the primary option has expired. Depending on the situation, the investor could continue to do this indefinitely over a long period of time.
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