Covered Calls Explained: Options Trading For Beginners
Published: 2023-07-20
Status:
Available
|
Analyzed
Published: 2023-07-20
Status:
Available
|
Analyzed
Predictions from this Video
Incorrect: 0
Prediction
Topic
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The video uses Intel (INTC) stock, trading at approximately $32 per share, as a case study for covered calls.
"we're going to be dealing with Intel stock ticker symbol INTC at the time of making this video Intel is at thirty two dollars a share"
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A specific covered call scenario involves selling a $34 strike price Intel call option expiring in two months for $1.50.
"and we're going to use the intel Call option that expires in about two months and that call option with a thirty four dollar strike price is selling for one dollar and fifty cents"
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If Intel stock drops, selling the call option for $1.50 offsets a $2 stock loss, resulting in a net loss of only $0.50.
"you made a dollar fifty by selling me the call option so you hedged and you're only down 50 cents instead of two dollars"
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If Intel stock price remains unchanged, selling the call option for $1.50 results in a profit.
"your stock did nothing and you made a dollar fifty"
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Selling the call option for $1.50 on Intel stock bought at $32 yields a 4.6% gain in two months, which annualizes to a 28% return.
"a dollar fifty divided by 32. which is what you paid for Intel that's a gain of 4.6 percent so you made a gain of 4.6 percent in two months so if you annualize that that's a rate of return of 28"
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If Intel stock rises by $1 and the call option is sold for $1.50, the total gain is $2.50.
"you made a dollar fifty by selling you the call option and your stock went up by a dollar so you're up two dollars and fifty cents in two months"
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A $2.50 gain in two months on Intel stock (bought at $32) from this scenario represents a 7.8% gain, annualizing to 46.8%.
"that's a 7.8 percent gain in two months annualized that's a rate of return of 46.8 percent"
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If Intel stock rises to $40, selling it at the $34 strike price and keeping the $1.50 premium results in a total gain of $3.50.
"you bought Intel at 32 you sell it to me for 34. so you make two dollars of gain on the stock and I paid you a dollar fifty to buy that call option from you so you make a dollar fifty there you walk away with a gain of 350 in total"
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A $3.50 gain in two months on Intel stock (bought at $32) results in an 11% gain, annualizing to 66%.
"that's an 11 gain in two months annualized that's a rate of return of 66 percent"
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A $34 strike price Intel call option with a six-month expiration is priced at $2.61.
"the 34 call option six months out is selling for two dollars and sixty one cents"
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Selling a $34 strike Intel call option yields $1.50, while selling a $38 strike option yields $0.50 for the same duration.
"you can sell the 34 call option two months out and make a dollar fifty or we can change the strike price to 38 and sell that option for 50 cents"
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If Intel's stock price is below the strike price ($34) at expiration, the sold call option expires worthless.
"if the price of Intel ends up below 34. then the call option that you sold expires worthless"
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Covered calls can generate income on a weekly, monthly, or annual basis, with the investor choosing the frequency.
"you will be paid income now this could be weekly income it could be monthly income annual income it's your choice"
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Selling a call option limits the potential profit if the underlying stock price increases significantly.
"when you sell the call option you are limiting your upside potential if your stock goes up"
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A covered call strategy involves buying a stock and then selling a call option on that same stock.
"you buy a stock and then you sell the call option this is a covered call"
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Longer-dated call options are more expensive, allowing the seller to collect more premium.
"the more time the call option has the more expensive the call option will be and that means that you as the seller would collect more money"
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Longer-dated options provide certainty of income, while shorter-dated options introduce price uncertainty for future premium collection.
"if you lock yourself into a longer call option then you know how much you're going to make in six months if you go with shorter time frames then you don't know how much the 34 call option will be selling for when the time comes"
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Choosing a higher strike price for a sold call option allows for greater potential profit from stock appreciation.
"if you go with a higher strike price then you're giving yourself more upside potential to make money on the stock"
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A higher strike price (e.g., $38) allows for selling the stock at a higher price if it appreciates, compared to a lower strike price (e.g., $34).
"if intel shoots up to 38 you're going to be forced to sell Intel at 38 but if you sold the 34 call option then you would be forced to sell Intel at 34."
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Call options with strike prices closer to the current stock price are more expensive; those further away are cheaper.
"the closer the strike price is to the current price the more expensive the call option becomes the farther the strike price the cheaper it becomes"
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The primary method to initiate a covered call is to first purchase the underlying stock, then sell the call option.
"in order to write a covered call you need to buy the stock first and then sell the call option"
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It is crucial to select fundamentally sound stocks when employing a covered call strategy to avoid losing money on the stock itself.
"do not buy a crappy stock because you don't want to make money by selling the call options but lose money on the stock"
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Each options contract typically represents 100 shares, meaning 100 shares of Intel are needed to write one covered call contract.
"with options you're dealing with 100 share increments so in this Intel example in order to do a covered call you need to buy 100 shares of Intel first"
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To write covered calls on 500 shares of Intel, five call option contracts would need to be sold.
"if you have 500 shares of Intel and you want to write covered calls on all 500 shares then it's going to look like this sell five call options"
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Investors can choose to write covered calls on only a portion of their stock holdings, rather than the entire amount.
"you don't have to write covered calls on all your stock if you have 500 shares of Intel you can write one contract you can write three contracts whatever you want"
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The premium from selling a call option is credited to the investor's account immediately upon execution of the trade.
"as soon as you sell the call option you receive that money immediately"
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Option premiums increase with longer contract duration, strike prices closer to the current stock price, and higher stock volatility.
"more time on the contract means more premium the closer to the strike price means more premium the more volatile a stock is means more premium"
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Investors should only pursue covered calls if the potential reward justifies the associated risks.
"if the risk is not worth the reward then don't do it"
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