Books about option trading have always presented the popular strategy known as the covered-call write as standard fare. But there is another version of the covered-call write that you may not know about. It involves writing (selling) 澳洲幸运5官方开奖结果体彩网:in-the-money covered calls, and it offers traders two major advantages: much greater 澳洲幸运5官方开奖结果体彩网:downside protection and a much larger potential 澳洲幸运5官方开奖结果体彩网:profit range.

🅘Read on to find out how this strategy works using aౠn in-depth example.

Traditional Covered-Call Write

Let's look at a historical example using Rambus (RMBS) shares, a company that manufactures and licenses chip interface technologies. We can begin by looking at the prices of May 澳洲幸运5官方开奖结果体彩网:call options for RMBS (see Figure 1 be𓄧low). While this may be an older example, the principles and mechanics still apply today and remain instructive.

RMBS closed on the date of our example at 38.60, and there were 27 days left in the May 澳洲幸运5官方开奖结果体彩网:options cycle (calendar days to expiration). Option premiums were higher than normal due to uncertainty surrounding legal issues and a recent 澳洲幸运5官方开奖结果体彩网:earnings announcement. If we were going to do a traditional covered-call write on RMBS, we would buy 100 shares of the stock and pay $3,860, and then sell an 澳洲幸运5官方开奖结果体彩网:at-the-money (ATM) or 澳洲幸运5官方开奖结果体彩网:out-of-the-money (OTM) call option. The 澳洲幸运5官方开奖结果体彩网:short call is covered by the long stock (100 shares is the required number of shares when one call is🎀 exercised).

At the time these prices were taken, RMBS was one of the most active stocks to write calls against, based on a screen for covered calls done after the close of trading. Looking at Figure 1 below, it would have been possible to sell the upside May 55 call at $2.45 ($245) against 100 shares of stock. This traditional covered call write would have upside profit potential up to the 澳洲幸运5官方开奖结果体彩网:strike price, plus the premium collec🧸ted by selling the option (i.e., up to $57.45ꩵ).

The maximum return potential at the strike by expiration is 52.1%. But there is very little downside protection, and a strategy constructed this way really operates more like a long stock position than a premium collection strategy. Downside protection from the sold call offers only 6% of a cushion, after which the stock position can experience un-hedged losses from further declines. Clearly, the 澳洲幸运5官方开奖结果体彩网:risk/reward seems misplaced.

An Alternative Covered Call Construction

Looking again at Figure 1, one could instead look to an in-the-money option to sell if there is enough time premium (澳洲幸运5官方开奖结果体彩网:extrinsic value) available on the 澳洲幸运5官方开奖结果体彩网:deep-in-the-money option. Looking at the May 25 strike, which is in-the-money by $13.60, there remains some decent time premium available, $1.20 ($120). In other words, if one sold the May 25, they could collect $120 in time premium (澳洲幸运5官方开奖结果体彩网:the maximum potential profit).

Figure 1: RMBS May Option Prices With the May 25 in-the-Money Call Option and Downside Protection Hig𓆉hlighted

Looking at another strikeౠ, the May 30 in-the-money call would yield an even higher p🍃otential profit than the May 25. On that strike, there is $260 in time premium available.

As you can see in Figure 1, the most attractive feature of the writing approach is the downside protection of 38% (for the May 25 write). The stock can fall 38% and still not have a loss, and there is no risk on the upside. Therefore, we have a very wide potential profit zone extended to as low as 23.𒆙80 ($14.80 below the stock price). Any upsideಌ move produces a profit.

While there is less potential profit with this approach compared to the example of a traditional out-of-the-money call write given above, an in-the-money call write does offer a near 澳洲幸运5官方开奖结果体彩网:delta neutral, pure time premium collection approach due to the high delta value on the in-the-money call option (very close to 100). While there is no room to profit from the movement 𝓀of the stock, it is possible to profit regardless of the direction of the stock, since it is the only decay-of-time premium that is the source of potential profit.

Also, the potential 澳洲幸运5官方开奖结果体彩网:rate of return is higher than it might appear at first blush. This is because the 澳洲幸运5官方开奖结果体彩网:cost basis is much lower due to the collection of $1,480 in 澳洲幸运5官方开奖结果体彩网:option premium 💜with the sale of the May 25 in-the-money call option.

Potential Return on in-the-Money Call Writes

As shown in Figure 2, with the May 25 in-the-money call write, the potential return on this strategy is +5% (maximum). This is calculated based on taking the premium received ($120) and dividing it by the cost basis ($2,380), which yields +5%. That may not sound like much, but recall that this is for a period of just 27 days. If used with margin to open a position of this type, returns have the potential to be much higher, but of c🌠ourse with additional risk.

If we were to 澳洲幸运5官方开奖结果体彩网:annualize this strategy and do in-the-money call writes regularly on stocks screened from the total population of potential covered-call writes, the potential return comes in at +69%. If you can live with less 澳洲幸运5官方开奖结果体彩网:downside risk and you sold the May 30 call instead, the potential return rises to +9.5% (or +131% annualized) - or higher if executed with a 澳洲幸运5官方开奖结果体彩网:margined account.

Fi🧸gure 2: RMBS May 25 in-the-Money Call Write Profit/Loss

The Bottom Line

澳洲幸运5官方开奖结果体彩网:Covered-call writing has become a very popular strategy among options traders, but an alternative construction of this premium collection strategy exists in the form of an in-the-money covered write, which is possible when you find stocks with high 澳洲幸运5官方开奖结果体彩网:implied volatility in their option prices. This was the case with our R🐼ambus exa📖mple.

These conditions appear occasionally in the option markets, and finding them systematically requires screening. When found, an i♑n-the-money covered-call write provides an excellent, delta-neutral time premium co😼llection approach—one that offers greater downside protection and thus a wider potential profit zone than the traditional at- or out-of-the-money covered writes.