By Chris Ebert
Generally, Covered Call traders can eke out a profit even when stock prices are flat or fall slightly, because they collect a premium on the option upfront when they sell it. So, for example, if a stock is trading at $100 and a trader sells a Covered Call with a $100 strike price and collects a $5 premium, the stock price can fall $5 and the Covered Call seller will still break even when the option expires. He loses $5 per share on the stock but puts $5 per share in option premium in his pocket; it’s a wash.
The downside of selling Covered Calls is that the maximum amount the seller can keep as profits on an at-the-money option is the initial option premium. So, in times of intense rallies, the Covered Call seller gets some profit but the buyer gets an immense amount of profit. While it does not occur often, such is the case now in many stocks in the S&P 500.
Folks who sold Covered Calls on $SPY and many stocks in the S&P four months ago are watching stock prices skyrocket. The buyers of those options are reaping huge profits. The sellers are keeping only the small option premium as profit. It happens occasionally. But what makes this week different than the past is that the S&P 500 is further above the point at which a Covered Call trader earns a profit. That means the buyers of those options are profiting more than they have ever profited before.
Since Covered Calls can survive with a profit or at least break even in small downturns or corrections, they can serve as (more…)