There’s been no shortage of ink spilled on current market conditions, with growth stocks in a bear market and the broader indexes in a choppy correction to start the year (S&P 500 down 10% YTD, Nasdaq down 15%). And if you’re sitting on a handful of underperforming or slightly positive positions, understanding how to use covered calls can help increase your profit potential.
The risk of covered calls is sacrificing some of your upside potential to put immediate cash in your pocket, but if you’re neutral on a position in the near term, the current high levels of volatility in the market are juicing premiums for call sellers. Keep in mind, this is still a net bullish trade, so if you’re bearish on a stock, a covered call strategy isn’t ideal to repair a broken position. Cutting bait may be the better option there.
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How to Use Covered Calls to Boost Your Profits
A covered call is a strategy that consists of owning an underlying stock and selling an option against the stock. Since a call option represents 100 shares of the underlying stock, you can sell one call against each 100 shares of stock you own. Because you own the stock, your short call position is “covered” by the stock.
A short option position by itself (without the stock) is very risky, and requires a substantial margin balance.
A short call on a stock you own, on the other hand, is a very conservative strategy that requires no margin.
I would recommend a covered call options strategy against virtually any stock an investor holds. In my mind, it’s free money, and best of all, it’s a great way to start learning about options and options trading.
Let’s dive a bit deeper into this how to use covered calls with a few stocks that have traded sideways.
Had I bought 100 shares of AMD a month ago, after 30 days I would be down 1.5%. That’s not a great return, but it’s far better than the 23% AMD is down YTD.
However, if I sold an AMD March 115 call for $8 against my stock holding, which is actually $800, my yield could be as high as 6.95% if AMD has another month of trading like the one it just had and the calls expire worthless.
The downside to this strategy is by selling a call against my stock holdings, if AMD exploded higher, I would not participate in the large stock gains, as the buyer of the call would have exercised his right to buy the stock from me. In the case of AMD, I would have made money until the stock traded above 115; however, above 115 my profits would have been capped.
The net result is that I would outperform by selling a call if AMD closes between 107 and 123 (because of the $8 premium received), but would underperform if AMD traded above 123.
That being said, in that scenario we still would have locked in profits ranging from 5% to 10% in one month’s time.
This is the exact strategy we use at Cabot Profit Booster, where we sell covered calls on Mike Cintolo’s weekly Cabot Top Ten Trader stock picks, which are 10 of the week’s strongest momentum stocks. We are looking to buy the best-looking stocks, as chosen by Mike, and then sell covered calls against those stocks to rack up yields ranging from 3-20% month after month.
If those sound like the kinds of monthly returns you’d be interested in – or if you simply want to learn more about covered calls or options trading in general – click here to become a Cabot Profit Booster subscriber.
Do you use covered calls? If so, tell us how they have enhanced your portfolio.
Jacob Mintz is a professional options trader and Chief Analyst of Cabot Options Trader. He uses calls, puts and covered calls to guide investors to quick profits while always controlling risk. Beginners and experts alike can gain from following Jacob’s advice.Learn More
*This post has been updated from a version originally published in 2021.