Covered Call Binary Option Strategy

Covered Call Binary Option Strategy

Submitted by adil on Mon, 11/10/2014 - 06:23

Covered call option strategy is more familiar to professional traders because most of them use this strategy as a safeguard against potential losses. Surprisingly, this strategy is very simple to learn and implement. It is not common because many new traders focus on learning those strategies that increase their profits. Only a handful of new traders are smart enough to quickly learn strategies that provide protection against big losses.

What a covered call trade really is?

If you have traded options then you would know that when a trader possesses some option trades, he also has the right to do whatever he wants with the relevant stocks. In normal circumstances, when the trader sells the stock or when the expiry time ends, the right of action also transfers with the stocks to the trader on the other side.

A covered call option differs in the way that the trader who currently has the right of action sells this right to another party before the expiry time, in return for an immediate cash payment which is usually equal to the strike price.

How covered call generates profits?

When the agreement is struck, the payment is transferred from the other party to the trader’s account. This payment is called the premium and it doesn’t depend upon the consequence of the option trade.

The advance payment ensures the trader receives the money before the day ends.

When a trader should sell covered call trades?

Covered calls are a calculated compromise. Simply put, the trader exchanges potential high value long term benefits with low value guaranteed short term benefits. Let us take an example. You purchase a set of stocks for $40 today with the expectation that their value will rise to $50 in six months. Suddenly you are in need of instant money, and cannot wait six months. Your best action would be to sell a small amount of stocks through covered call to an interested party at $45 per stock.

You receive less profit but it is completely guaranteed. But if the market conditions at the time of expiry remain favorable, then the trader may not get a lot of potential profit.

But when the market conditions worsen and the trader has to sell stocks at prices lower than at what he bought, then in such cases the covered call would surely return some of his money in advance.

When covered call will generate losses?

A very dangerous situation can happen if the trader sells most of his stocks in covered call trade and doesn’t re-buy the stocks at a sufficient time to cover for the original option trade. The trader must have the original number of stocks before the expiry time in order to execute the trade. In some cases, the trader is forced to buy very costly stocks just to prevent his other stocks from expiring with all his investment. Selling options for stocks the trader doesn’t have is called “naked call” and can generate high losses.