Covered Call Trading Weather

Covered Call trading is often touted as a great way to earn income from stocks that a trader already owns. The trader sells a Call option on the owned stock and collects a fee known as the option premium.
The problem with selling a Covered Call option is that it limits the profits on the stock if the stock price rises. When the stock price rises above a certain price, known as the option strike price, all profits beyond that point are lost and go to the buyer of the option.
Option trading can seem daunting to those who have never done it. But Covered Call trading is relatively simple. A trader who owns 100 shares of stock can sell what is known as a Call option, which essentially gives up the right to profit on that stock. In return, the seller collects capital in the form of an option premium. Most brokers can walk a trader through the process; many traders qualify with a simple request to their broker to trade Covered Calls.
Selling Covered Calls is generally not a good idea in a strong rally, because the buyer of the Call option is reaping huge profits while the seller is getting just a small premium. Exacerbating the situation is that when a strong rally is in progress, implied volatility is low – and implied volatility is a measure of option premiums. Quite simply, when there is a rally in stock prices, option premiums tend to decrease, so that sellers of Covered Calls are collecting very small premiums yet giving up huge profits to the buyers of the Calls.

This post was published at ZenTrader on March 13, 2017.