By Before we discuss the key mistakes you need to avoid when selling covered calls, let’s first and foremost understand the definition of a covered call.
Definition of a Covered Call
What is a covered call in options trading? A covered call is a risk management and an options strategy in which the investor who sells call options owns an equivalent amount of the underlying security.
Now that we’ve understood the meaning, we are sure you’d like to also know if covered calls are worth selling or not.
Is Selling Covered Calls Worth It?
Before focusing your energy on this business career, you need to be sure if it’s worth the effort. And the right answer is yes. Selling covered calls are worth it and we will tell you why.
Why is selling covered calls worth it? One of the primary reasons we recommend selling covered calls is because it helps you to reduce risk in stock trading. With covered calls, you are certain of taking profit whether stocks are going up or down.
There’s a no better approach to reduce losses, manage stock trading risks and mistakes, and protect your capital investment if not through covered calls.
If selling covered calls can help you to manage risks and protect your capital, can you still lose money?
Do You Lose Money on a Covered Call?
Choosing covered calls as an investing strategy does not give you guaranteed money. It only reduces the risk of losing a trade. To increase your chances of making money with covered calls, you need to know your break-even before you place a trade. Knowing the maximum profit and loss on a covered call strategy will help you.
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Before venturing into writing covered calls, let’s look at some of the common mistakes to avoid.
Common Mistakes to Avoid When Writing Covered Calls
Here are common errors in options trading. If you can avoid these mistakes, you stand a much better chance of success.
Mistake #1: Selling Covered Calls at the Wrong Strike Price or Expiration
Do not make the mistake of choosing to write calls at the wrong strike price or expiration. You will need to have a solid understanding of the risks and rewards involved with each selling strategy. Strategy is everything when it comes to option trading.
What is a strike price in options trading? The strike price of an option is the price at which a call option can be exercised. The strike price to a large extent can decide how profitable your investment will be.
One of the biggest mistakes to avoid is choosing the wrong strike price or expiration when selling covered calls. The two types of strike prices when selling a covered call are out-of-the-money calls and in-the-money calls.
What is the difference between an Out-of-the-Money call and the In-the-Money call? An Out-of-the-Money (OTM) call has a strike price that is higher than the current stock price. While an In-the-Money (ITM) option has a strike price less than the current market price.
Mistake #2: Forgetting to Close Short Calls if the Value is at or Near Zero
One of the most common mistakes to avoid when selling covered calls are forgetting to close out a profitable covered call position. Once a short call falls near the zero level, it’s time to close it because it has reached its maximum profit potential.
It is not possible for a short option that has lost all of its value to make a covered call writer any more money because all of the value has already been extracted.
Whenever this happens, covered call traders are advised to close out the short call options. Forgetting to close out short covered calls with a value of zero is the same as holding on to a short stock position that has fallen to zero. What is the result? Loss! Loss!! And more loss!!!
Mistake #3: Expecting Immediate Returns from Selling Covered Calls
On Reddit and Quora, you will read a lot about how to become successful selling covered options. In all the advice you will read about, one of the mistakes you shouldn’t make when selling covered calls is expecting returns too early.
Even though options trading is a profitable investment, there’s no guarantee. It’s not a get-rich-quick scheme. So? Don’t expect to hit millions of dollars overnight. You must be ready to apply the long-term approach.
Like every other investment opportunity in the United States, you must be ready to trade what you can afford to lose. But an ROI of 10-12% per year isn’t a bad idea.
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What Happens If We Don’t Sell Our Call Option?
Nothing happens. Whatever is due to you, if your bought strike option is ITM ( IN THE MONEY ) will come to your account. If it’s OTM ( Out Of Money ) nothing comes and you lose the premium paid.
