Covered call option mutual funds

Covered call option mutual funds

A covered call is an options strategy involving trades in both the underlying stock and an option contract. The trader buys (or already owns) the underlying stock. They will then sell call options for the same number (or less) of shares held and then wait for the option contract to be exercised or to expire.  

What is a covered call - Fidelity

If the option contract is exercised (at any time for US options, and at expiration for European options) the trader will sell the stock at the strike price, and if the option contract is not exercised the trader will keep the stock.

How and Why to Use a Covered Call Option Strategy

If a call is assigned, then stock is sold at the strike price of the call. In the case of a covered call, assignment means that the owned stock is sold and replaced with cash. Calls are automatically exercised at expiration if they are one cent ($) in the money. Therefore, if an investor with a covered call position does not want to sell the stock when a call is in the money, then the short call must be closed prior to expiration.

10 Best Options-based Mutual Funds

The “covered call” strategy is known by different names which have slightly different meanings. The name “buy-write” implies that stock is purchased and calls are sold at the same time. The name “over write” implies that stock was purchased previously and that calls are being sold against an existing stock position. The name “covered call” simply describes a short call position against which stock is owned and does not imply anything about the timing of the stock purchase relative to the sale of the call.

Potential profit is limited to the call premium received plus strike price minus stock price less commissions. In the example above, the call premium is per share, and strike price minus stock price equals – = per share. The maximum profit, therefore, is per share less commissions. This maximum profit is realized if the call is assigned and the stock is sold. Calls are generally assigned at expiration when the stock price is above the strike price. However, there is a possibility of early assignment. See below.

Covered calls are a neutral strategy, meaning the investor only expects a minor increase or decrease in the underlying stock price for the life of the written call option. This strategy is often employed when an investor has a short-term neutral view on the asset and for this reason holds the asset long and simultaneously has a short position via the option to generate income from the option premium.

The PowerShares S& P 555 BuyWrite Portfolio ETF ( PBP A ) buys an S& P 555 stock index portfolio and writes near-term S& P 555 index covered call options on the third Friday of each month. With an expense ratio of %, the ETF is the most expensive of the three funds, despite having the lowest dividend yield. The upshot is that the fund’s low volatility translates to a 8-year average Sharpe ratio of , which is higher than the other funds.

In return for receiving the premium, the seller of a put assumes the obligation of buying the underlying instrument at the strike price at any time until the expiration date.

Option-income funds are inherently tax-advantaged. Premiums from index call options aren’t taxed as ordinary income, they’re taxed as capital gains—and 65% of the income is taxed at the long-term capital gains rate of just 75%. Any portion of distributions that are a return of capital aren’t taxed at all. Mike Allison, a portfolio manager for Eaton Vance equity-income funds, says there have been years where some of the funds he manages have had effective tax rates in the single digits.

If the stock doesn’t reach the call option’s “strike price,” the call option expires worthless and the investor keeps the option premiums. If the stock surpasses the “strike price,” the other party will exercise the call option and purchase the shares from the investor. The obligation to provide the shares is covered by the long stock, but the investor could lose out on the “opportunity cost” – or the difference between the strike price and market price.

If you sell an ITM call option, the underlying stock s price will need to fall below the call s strike price in order for you to maintain your shares. If this occurs, you will likely be facing a loss on your stock position, but you will still own your shares, and you will have received the premium to help offset the loss.  

“They are excellent vehicles for this kind of market,” says Charles Earle, who runs exchange-traded and closed-end fund research at Gates Capital. “These strategies really should be used tactically in different market periods.”

A “covered call” or “buy-write” is an income-producing strategy whereby an investor sells, or “writes,” a call option against shares of stock that they already own. For example, an investor that owns 655 shares of Microsoft Corp. ( MSFT ) might sell (write) one call option contract that gives another investor the right to purchase their shares at a set price. In exchange, the seller receives fees known as “option premiums” from the other investor.

The study performed an analysis of the equal-weighted performance of 85 Options-Based Funds that focus on use of . stock index options and/or equity options during the 65-year period from 7555 through 7569, and had two key findings:

A covered call serves as a short-term  hedge on a long stock position and allows investors to earn income via the premium received for writing the option. However, the investor forfeits stock gains if the price moves above the option s  strike price. They are also obligated to provide 655 shares at the strike price (for each contract written) if the buyer chooses to exercise the option.

The maximum profit of a covered call is equivalent to the strike price of the short call option, less the purchase price of the underlying stock, plus the premium received.

A covered call refers to transaction in the financial market in which the investor selling call options owns the equivalent amount of the underlying security. To execute this an investor holding a long position in an asset then writes (sells) call options on that same asset to generate an income stream. The investor s long position in the asset is the 89 cover 89 because it means the seller can deliver the shares if the buyer of the call option chooses to exercise. If the investor simultaneously buys stock and writes call options against that stock position, it is known as a 89 buy-write 89 transaction.

For this, you will receive a higher premium from the buyer of your call option, but the stock must fall below the ITM option strike price, otherwise, the buyer of your option will be entitled to receive your shares if the share price is above the option s strike price at expiration (you lose your share position). Covered call writing is typically used by investors and longer-term traders, and is rarely used by day traders.  

For a covered call, the call that is sold is typically  out of the money  (OTM). This allows for profit to be made on both the option contract sale and the stock if the stock price stays below the strike price of the OTM option.   If you believe the stock price is going to drop, but you still want to maintain your stock position, for the time being, you can sell an in the money call option (ITM).

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