David Jaffee of BestStockStrategy.com does not recommend owning stock.
Stocks are very capital inefficient and owning stocks does not provide you with the highest probability of profit (there is a better way).
Instead of buying 100 shares of a stock, you are much better off selling a put on the stock (assuming that the stock has listed options available to trade).
In the worst case scenario, you end up owning 100 shares of the stock and you collect the premium from selling an option.
Your acquisition price for the shares is also lower than buying stock on the open market.
But, if you are long 100 shares of a stock, you can still act like an insurance company and collect option premium by selling short-dated covered calls.
While covered calls are not David Jaffee’s favorite options trading strategy, he has identified scenarios where they are useful.
For traders that prefer to increase their returns with options, selling covered calls can help you make money from the shares you already own.
Keep reading to learn about how to sell covered calls for a profit and minimize your trading losses.
What are covered calls?
If you own a stock or futures contract, you have the right to sell the underlying security at the market price at any time.
By writing a covered call, you give the right to sell the security to someone else in exchange for a premium.
The option buyer has the right to own your security at the strike price on or before the expiration date, and you collect the premium for selling the covered call.
Covered calls offer a way to capitalize on shares you already own by leveraging your existing shares to earn income (collecting option premium).
When you sell a covered call, you get to keep the premium regardless of the outcome on the expiration date.
If the call option expires out of the money, you get to keep your shares and the premium collected from selling the option.
You have also successfully lowered the total acquisition cost of your shares by collecting cash in the sale of the option.
If the call option expires in the money, the call option buyers buys your shares at the strike price.
While you no longer own your shares, you make money by selling the shares at a higher price than you paid for them and you get to keep the premium for selling the option.
What's the downside? The downside with covered calls is that if the underlying stocks appreciates in value very rapidly, then you will not be able to profit from the price appreciation above your strike price.
For example, if you sell a covered call with a strike of $60 when the underlying stock is trading at $50, and then the stock appreciates to $65, you will sell your shares at $60 (and keep the premium collected), but you will not be able to sell your shares at $65.
Selling Covered Calls for Income
David Jaffee does not recommend selling covered calls as your main options trading strategy.
If you are already trading successfully or you prefer to own stock, you can add an incremental 5% - 10% to your portfolio on an annual basis by selling covered calls.
Covered calls are decent for some traders, but, in my opinion, there are better options for long-term options trading that yield better returns.
If you want a passive strategy, you can buy an ETF and sell covered calls, or keep reading to learn a better way to invest.
Downside of Selling Covered Calls
To sell covered calls, you have to own stock.
Owning stock is more risky than simply selling a put (and it is less capital efficient).
When you sell a covered call, you must also resign yourself to either holding the long position or selling your shares at the strike price.
If the price of your stock continues to increase past the strike price, you miss out on the extra profit above your strike price.
If the stock never reaches the strike price, you have to be comfortable holding on to your shares for a longer period of time and waiting until the market value rises.
David Jaffee encourages his students to act like a casino, not a gambler, to get the best options trading results.
When selling covered calls, you are playing both roles and you collecting option premium (which is good).
Selling covered calls can help you earn money on your existing holdings by collecting option premium, but you may end up holding on to shares for a long time.
Who should use covered calls as an options trading strategy?
There are some traders who benefit from selling covered calls.
David Jaffee recommends this options trading strategy to older traders or traders who are more risk adverse.
If you do not have the time or interest to learn how to trade options successfully, you can add selling covered calls to your strategy and incrementally improve your position.
Covered Calls are Okay. But there’s a Better Way to Trade Options.
If you are not overly impressed with covered calls, you are not alone.
In his online options trading course, David Jaffee offers the best options trading strategy.
By selling option premium, traders can earn consistent profit.
The strategy does carry higher portfolio volatility, but this volatility is oftentimes rewarded with greater returns.
If you want to win 95%+ of your trades, you have to learn how to successfully sell option premium and leave owning stocks behind.