# In-The-Money Covered Call

Writing in-the-money calls is a good strategy to use if the options trader is looking to earn a consistent moderate rate of return.

 Covered Call (ITM) Construction Long 100 Shares Sell 1 ITM Call

Profit is limited to the premium earned as the writer of the call option will not be able to profit from a rise in the price of the underlying security.

Offers more downside protection as premiums collected are higher than writing out-of-the-money calls.

Covered Call (ITM) Payoff Diagram

## Limited profit

As the striking price is lower than the price paid for the underlying stock, any upward price movement will not benefit the call writer since he has agreed to sell the shares to the option holder at the lower striking price. Therefore, the maximum gain to be made writing in-the-money calls is limited to the time value of the premium at the time of writing the call.

The formula for calculating maximum profit is given below:

• Max Profit = Premium Received - Purchase Price of Underlying + Strike Price of Short Call - Commissions Paid
• Max Profit Achieved When Price of Underlying >= Strike Price of Short Call

## Greater downside protection

As the premiums received upon writing in-the-money calls is higher than writing out-of-the-money calls, downside protection is greater as the higher premium can better offset the paper loss should the stock price go down.

The formula for calculating loss is given below:

• Maximum Loss = Unlimited
• Loss Occurs When Price of Underlying < Purchase Price of Underlying - Premium Received
• Loss = Purchase Price of Underlying - Price of Underlying - Max Profit + Commissions Paid

## Breakeven Point(s)

The underlier price at which break-even is achieved for the covered call (itm) position can be calculated using the following formula.

• Breakeven Point = Purchase Price of Underlying - Premium Received

## Example

Suppose the stock XYZ is currently trading at \$50 in June. An options trader decides to write a JUL 45 covered call for \$7. He pays \$5000 for the 100 shares of XYZ and receives \$700 in premium giving a net investment of \$4300.

The stock then rallies to \$55 at expiration and the call gets assigned. As per the options contract, the trader has to sell the 100 shares of XYZ at the striking price of \$45 and so he receives \$4500 for the shares sold. Since his original investment is \$4300, his net profit for the entire trade is only \$200.

However, should the stock price go down to \$45 instead, he still makes a profit since the \$700 in premiums received more than offset the \$500 in paper loss of the 100 shares he held which has lost \$5 a share in value.

At \$45, the call most likely will not get assigned since there is no intrinsic value left in the option. Since the shares did not get called away, the call writer can either sell the shares for \$4500 giving him a net profit of \$200 for the entire trade or write another call against the shares held.

Note: While we have covered the use of this strategy with reference to stock options, the covered call (itm) is equally applicable using ETF options, index options as well as options on futures.

## Commissions

For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around \$10 to \$20) and varies across option brokerages.

However, for active traders, commissions can eat up a sizable portion of their profits in the long run. If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only \$0.15 per contract (+\$4.95 per trade).

## Similar Strategies

The following strategies are similar to the covered call (itm) in that they are also bullish strategies that have limited profit potential and unlimited risk.

Uncovered Put Write
Stock Repair Strategy
Covered Straddle

## Continue Reading...

### Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results....[Read on...]

### Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount....[Read on...]

### What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time.....[Read on...]

### Investing in Growth Stocks using LEAPSÂ® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPSÂ® and why I consider them to be a great option for investing in the next MicrosoftÂ®.... [Read on...]

### Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date....[Read on...]

### Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative....[Read on...]

### Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date....[Read on...]

### Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin....[Read on...]

### Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading.... [Read on...]

### What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator.... [Read on...]

### Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa.... [Read on...]

### Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as "the greeks".... [Read on...]

### Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow.... [Read on...]

#### Options Strategy Finder

Outlook on Underlying:

Profit Potential:

Loss Potential:

Credit/Debit:

No. Legs:

Risk Warning: Stocks, futures and binary options trading discussed on this website can be considered High-Risk Trading Operations and their execution can be very risky and may result in significant losses or even in a total loss of all funds on your account. You should not risk more than you afford to lose. Before deciding to trade, you need to ensure that you understand the risks involved taking into account your investment objectives and level of experience. Information on this website is provided strictly for informational and educational purposes only and is not intended as a trading recommendation service. TheOptionsGuide.com shall not be liable for any errors, omissions, or delays in the content, or for any actions taken in reliance thereon.

 General Risk Warning: The financial products offered by the company carry a high level of risk and can result in the loss of all your funds. You should never invest money that you cannot afford to lose.

Home | About Us | Terms of Use | Disclaimer | Privacy Policy | Sitemap

Copyright 2017. TheOptionsGuide.com - All Rights Reserved.