Selling In the Money Covered Calls Strategy Question

L

LaxFan

Relative newbie question here about selling in the money covered calls. My example based on an actual stock I'm looking at:

Buy XYZ 100 shares at $51
Sell in the money covered call for $1.20 premium with a strike of $50.

At expiration, the stock is above $50.

In this case, I lose $100 on the stock (as it's called away at 50), but gain $120 from the call premium. Thus gaining $20 per contract.

Is this a legit strategy?

Is this a common strategy to use where a trader plans to take a loss on the stock, but comes out ahead because the premium is greater than the stock loss?
 
i did this strategy last week to buy LK at $29.668 and sell its $29 calls weekly, 6000 shares and 60 lots. The 29 call's IV was as high as 70% to produce a premium of $1.4. This strategy worked last week as LK closed on 12/6 at around $29.7, allowing me to pocket a gain of 4K+ for the week. But all the stocks and options are all gone of course, so i have to start out a whole new week tonight at my local time.

I live in Taiwan and select stocks basically doing business in China, such as BIDU, BABA, PDD, NIO, to name just a few. have to admit that i am a little bit of China biased stock selection person. hope not bother you guys here.
 
It's legit and somewhat common strategy, but I don't see any edge here. Options are priced based on probabilities, so you would need to figure out more active method of trading. Or find a stock that doesn't move while offering decent premium. In your case the risk is not on the upside but on the downside, if the stock drops by $2, for example.

You may also want to learn/understand that your example is mathematically equivalent to not buying a stock and not selling covered call on it, but selling naked put at $50 strike instead. That put should cost $0.20 and by selling it you get the same $20 premium per contract. But if the stock price drops then you'd have to buy the stock (by being assigned stock) at the lower price, thus ending up with the same exact outcome as if you'd already owned that stock.
Thus thinking about this as selling naked puts may help you look at this strategy differently. Selling covered calls is always 100% equivalent to selling naked put at the same strike.
 
guru said:
Thus thinking about this as selling naked puts may help you look at this strategy differently. Selling covered calls is always 100% equivalent to selling naked put at the same strike.
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^^
What he said. If you understand him, you probably won't want to do it. If you don't understand him, and most likely you don't, then for what should be obvious reasons, you shouldn't do it.
 
I do understand, however, by buying the stock first and selling the covered call aren't I able to collect dividends in the meantime and then sell another covered call against it after expiration?

Wouldn't that be a difference or advantage versus just a naked put (which I can't do anyways as I just have a cash account and no margin)? Wouldn't that enable me to generate more income and lower my basis on the whole position (even though IRS doesn't treat basis that way).
 
The problem is someone exercises the option early to collect the dividend or stock goes down and you want to close the positions.
 
LaxFan said:
I do understand, however, by buying the stock first and selling the covered call aren't I able to collect dividends in the meantime and then sell another covered call against it after expiration?

Wouldn't that be a difference or advantage versus just a naked put (which I can't do anyways as I just have a cash account and no margin)? Wouldn't that enable me to generate more income and lower my basis on the whole position (even though IRS doesn't treat basis that way).
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Dividends are already priced into options, exactly to prevent arbitraging such situations. Otherwise you’d be taking free money away from someone else who’d have to lose it for no other reason than not doing the same you do. Or if everyone caught on then who the free money would come from?

Cash account doesn’t matter because cash/margin requirements are the same for mathematically equivalent trades. If your cash account allows you to buy 100 shares then it should also allow you to sell naked put that controls 100 shares or may convert to 100 shares. You’re risking losing money on 100 shares in both cases.
 
Btw, if you hold such stock long-term then indeed you could benefit from dividends as an investment strategy. Just selling calls against it or naked puts wouldn’t really do anything different than holding or doing the same with a stock that doesn’t pay dividends, because both calls and puts are priced differently on dividend vs non-dividend stocks. And in both cases selling covered call vs naked put would still be equal.
You may benefit from holding dividend-paying stocks, while basic selling of covered calls may sometimes be profitable and sometimes not - just as with all stocks.

You don’t need to sell naked puts either. It was just info to help think about selling covered calls differently and understand how the whole concept works.
There are some indexes and ETFs called PutWrite that utilize selling covered calls or selling naked puts (since they are equivalent), and not doing better than holding the underlying.
 
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OK, Thanks for the clarifications. Guru, I do like the idea of selling calls against stocks I own. Just looking at conservative moves, not anything where I'm expecting to create giant profits.

I feel like selling calls against a stock I own can give me some extra income and downside protection. I realize it limits any gains.
 
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guru said:
Btw, if you hold such stock long-term then indeed you could benefit from dividends as an investment strategy. Just selling calls against it or naked puts wouldn’t really do anything different than holding or doing the same with a stock that doesn’t pay dividends, because both calls and puts are priced differently on dividend vs non-dividend stocks. And in both cases selling covered call vs naked put would still be equal.
You may benefit from holding dividend-paying stocks, while basic selling of covered calls may sometimes be profitable and sometimes not - just as with all stocks.

You don’t need to sell naked puts either. It was just info to help think about selling covered calls differently and understand how the whole concept works.
There are some indexes and ETFs called PutWrite that utilize selling covered calls or selling naked puts (since they are equivalent), and not doing better than holding the underlying.
More...

One final followup: Since selling covered calls and naked puts are mathematically equal, why would one choose one over the other?
 
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