Buy low and sell high seems to have been a motto for investors since the beginning of time. But what if things don’t play out exactly as planned? If you own the stock, you may think there’s not much you can do to increase your net worth if the stock trades sideways. But as traders and investors with knowledge of equity options know, using a covered call when the stock is trading sideways can make perfect sense.
AAPL Example
Let’s look at a recent example in Apple Inc. (AAPL). As you can see from the hourly chart below, AAPL had been trading in a channel for several weeks after falling from previous highs. The market at that time was generally moving higher. That can be frustrating for an investor of Apple stock.
Using a Covered Call Strategy
A covered call is owning stock and selling a call option that is usually out-of-the-money (OTM). You have the obligation to sell your shares if the stock closes above the strike price at expiration. If the stock closes at or below the strike price, the option expires worthless. Generally, an investor can sell a call for every 100 shares. As the chart above shows, in this example the $205 level had been acting as a very nice resistance level. An investor could use a covered call strategy by selling a 205 call.
As seen below, a 205 call with just under 8 days to go until expiration could be sold for 0.99 (or $99 in real terms). If AAPL were to close at or below $205 by expiration, the option would expire worthless. The option could also be bought back before expiration, below or above the $205 level. Even if the option is bought back for more than it was sold, the stock gain would produce an overall profit for the position depending on the initial purchase price. If you did that every week or every two weeks, just think of the extra premium that would accumulate—even if $99 was not realized every time you sold a 205 call or another level.
Final Thoughts
Obviously, there’s no guarantee a covered call will work this efficiently in every situation. Sometimes the best thing to do is to sell the shares if the stock declines. But with a neutral to slightly bearish forecast, selling premium by way of covered calls can increase your P&L and sometimes in a big way. There is so much to love about options, and this strategy is close to the top of my list.
John Kmiecik
Senior Options Instructor
Market Taker Mentoring
