The covered call is one of the best strategies for a beginning trader to utilize as they venture into options trading. This strategy is an easy transition from the conventional approach to investing that focuses primarily on a long equity position. That’s because a covered call is nothing more than layering a short OTM call on top of that existing long stock position. You are able to enjoy any gains between the current stock price and the strike of your short call option. Any movements in the underlying above your short strike will be a non-event, as the profits from your long stock will be canceled out by the losses on your short call.
Covered calls yield a higher probability of profit than a straight stock position due to the cost basis reduction that the strategy utilizes. The reason why is with a long stock position we only make money if the underlying moves higher – a 50/50 proposition. But, with a covered call, not only do we make money if the underlying moves higher, but we also make money if the underlying goes nowhere. This is why our covered call positions can have POPs of 55%, 60%, or even higher. The tradeoff is that we must forgo the extreme upside in exchange for this higher probability of success. But, as we have learned here at tastylive, improving the probabilities to work in our favor puts us on the path to success.
NOTE: You’ll noticed during the segment I make reference to the graph being incorrect as I work through that slide. It has been corrected for the archives.
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