This is going to be a short article, but I’d like to share a great income strategy for those who are dabbling in options trading. If you’re learning about options as I am, you’re probably familiar with covered call writing as this is a very basic strategy great for beginners. Typically when we write calls, they are OTM strikes and we’re happy if the stock trades sideways or goes up because in either scenario we keep the premium and in the latter, we lock in our max profit. But what if I told you about another variant of the covered call strategy where you write ITM calls instead?
Now before you call me an idiot and start hurling names, let me just preface by saying that this does not work for all stocks. I like to use FinViz as a screener and since my workplace prevents me from trading stocks without pre-clearance, I’m mainly restricted to ETFs but this strategy also works for stocks as well. Let’s work through a basic scenario so that we understand how you can profit off of writing ITM covered calls.
One ETF that I’m bullish on is XLF, which covers the financial sector (if you’ve been reading our previous articles, you’ll know why I’m bullish on financials so I’m not going to cover that in this article. You can read more about my outlook here).
XLF is currently trading at $34.45 per share as of this article’s publish date. The basics of a covered call involves buying in multiples of 100 of the underlying stock and selling call contracts on that multiple (so selling 1 contract per 100 shares for you complete noobs). Normally we’d usually sell an OTM contract meaning anything above the stock’s current trading price but we’re going to sell an ITM option instead.
So instead of selling a call with a strike above the current trading price, we’re looking for an ITM option. In this scenario, I picked $27.50 as my strike which is ITM because it’s below the current trading strike. This option expires on Friday, 4/9/21 and we’ve collected a $718 premium for writing this option. This lowers our cost basis from $34.45 to $27.28 so as long as the underlying remains above $27.28, we’ll make a $22.50 total profit. This gives us roughly ~20% cushion in case the underlying drops, eg. the stock would have to drop greater than 20% by expiration day for us to make a loss. This is also a great hedging strategy for those with restricted accounts (eg. can’t trade spreads).
Now you may ask, how do we find these opportunities? Well unfortunately I don’t have a great answer. What I do is I pop over to FinViz, set average volume to above 100k, industry to ETFs (or stocks only if you don’t want ETFs), and performance to week up. Then sort by volume from highest to lowest as we only want liquid stocks and then comes the hard work of looking for options with a sufficient premium and supporting technicals and fundamentals. This is easier said than done and not all stocks can support this strategy so do your own due diligence. Let me know your thoughts and as always, happy gambl – er investing!