Do you have a question for the Option Scientist? Email questions to options cientist zentrader. Email addresses will not be published. I am a novice on options and beginning to learn and play covered calls now. It seems to me that when I buy and write a covered call, it is easier than having underlying stock and writing a call later. Thanks for sharing your precious experience and time to help people like me. So the answer has been split into two parts: Buy-Write Trading, the difference between the two strategies is explored.
Tomorrow, in Part 2 the similarities will be explained, including stop losses and price targets. Although there is no difference between a covered call that is opened on previously-purchased stock and a covered call that is opened as a buy-write, there can be a major difference in the reason for opening the trade.
Let's start with the covered call on stock that is already owned. Resistance can sometimes signal a turning point for a stock, and the share price may subsequently fall considerably. Resistance can also mark a pause in trading, almost as if traders have bitten off more than they can chew. In these cases the stock price may move sideways for a time, as the previous gains are digested, followed by a resumption of the uptrend.
After all, in an account with limited funds and so many other stocks to choose from, sitting on a stock that has hit a brick wall may not represent the best use of those funds. But a covered call can take advantage of resistance to generate income, thereby making better use of those funds. Unfortunately, the additional profit is not a guarantee. It is quite possible that the stock price could fall after hitting resistance. That's no better off than if the stock had just been sold in May, but it does present an additional opportunity.
Once the call option has expired worthless, the covered call seller is under no obligation to sell the stock. In this scenario, selling the covered call on previously-owned stock allowed the stockholder to ride out the digestion period without giving back any gains, and keep the stock for a possible post-digestion rally.
It is entirely possible for the stock price to fall far enough to eat up no only the profits from a covered call, but also the unrealized gains on the stock itself.
Which dessert is best? Well…nobody want's crumbs, so throw that one out! Icing on the cake is nice. But it can be argued that having your cake and eating it too is actually preferable. That's because whatever method of fundamental or technical analysis the trader employed in making the decision to sell the covered call, the analysis was correct.
The trader has proven to have a good handle on this stock, and that may allow the trader to continue to profit from this stock in the future.
On the other hand, as nice as it is to have icing on the cake, it proves that the trader's analysis was flawed. The trader does not have a good handle on this stock, and is less likely to profit on this stock in the future.
While it is possible to use a buy-write trade to earn profits from a stock that is moving sideways or declining in price, it is not an optimal use of the strategy. However, profits are the result of time decay eating up the value of the call option. To a covered call seller on a sideways-trading stock, time decay can feel like it is moving at a glacial pace.
But the profit will tend to occur much more quickly in an uptrend. Resistance can provide a distinct advantage for a covered call sold against previously-purchased stock, while the absence of resistance provides an advantage for a covered call opened as a buy-write. That's quite a difference! The preceding article is from one of our external contributors.
It does not represent the opinion of Benzinga and has not been edited. Options Markets Trading Ideas. Membership is Free What are you waiting for? Free Account Login Click here to access your premium account. Contribute Login Sign up. Benzinga - Feed Your Mind. Covered Call Trading Vs. Buy-Write Trading Part 1. March 04, 2: Covered calls can be opened two different ways: A call option can be sold when a trader owns at least shares of stock 10 shares if using the new mini options.
The process of selling an option technically requires that a contract be written and then offered for sale on an options exchange. However, over the years the process has become automated. Nowadays a contract can be written electronically. While it is somewhat confusing, selling a call option is also known as writing a call option.
When a trader already owns the required number of shares of stock for a standard call option or 10 for a mini call option selling a call option is known as either selling a Covered Call or writing a Covered Call.
A call option can be sold at the same time a trader purchases shares of stock 10 shares if using the new mini options. This is also known as selling a Covered Call or writing a Covered Call. There are three possible outcomes: View the discussion thread. Subscribe to our free newsletters:. Market in 5 Minutes. If you have any questions as it relates to either of the three newsletters, please feel free to contact us at ZING. Benzinga is a fast-growing, dynamic and innovative financial media outlet that empowers investors with high-quality, unique content.
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