How to Trade Covered Calls Properly (The 3 keys to Uncommon Profits)

most Traders do not know how to trade covered calls properly and remain stuck in crappy trades for way too long in this video we teach you the three keys that can double and even triple the annualized returns that conventional covered called Traders make I'm Mike Bella Fury and we're one of the top proprietary trading firms located in New York City and proud to develop num 7 and even a figure period Traders we hope you discover this is the top YouTube channel to help you grow your trading account hi I'm Seth freyberg and I'm the head Trader of S&B capitals options trading desk here in Manhattan and we're constantly receiving inquiries from Traders all over the world about the topic of covered calls and how to trade them properly and so today's video is going to be on the right way to trade covered calls and specifically the top three most important tips to understanding how to trade covered calls in the most optimal way which can provide you with double or even triple the income that you would have received trading covered calls in the traditional manner in other words these are the techniques that professional options Traders use to maximize their covered call profits cash flow and returns if you're brand new to options trading and you don't know much about uh trading options and how they work we've created a video for you to understand options Basics and if you click the video appearing on your screen right now it will lay the groundwork for understanding the covered call Strat will be teaching you in this video Then when you're finished you can just come back and watch the rest of the video before we get into the three keys to optimizing your covered call income let's make sure that everyone understands what's meant by a traditional covered call so we're going to do a really quick review of them and then jump right back into the three keys to maximizing covered call income okay so a covered call starts out with you buying a 100 shares of a stock and then selling a call option on those shares that you own usually at a strike price at or above the current stocks price at a fixed interval like once a month or once a quarter and so a covered call can have two possible outcomes if the stock closes at any price below the strike price of the call option on the day that option expires the trader just Pockets that call Premium that he received initially but if the stock closes above the strike price of the call option he sold then his shares get sold for the strike price of the call he sold and again he Pockets the premium that he originally collected for selling that call so that's the way that covered calls work the first key to maximizing your profits on covered calls is this stop trying to squeeze every last penny out of a covered call it's going to kill your returns now why would squeezing every last penny out of your covered call income actually kill your returns well let me give you an illustration let's say an investor owned 300 shares of Apple on December 17th 2021 when the stock was trading a little bit over 171 and so let's say that the trader had decided to implement a quarterly covered call program on those 300 shares so he goes out about three months and pulls up an options chain for Apple's March expiration and he looks at the closest call strike where the stock is trading which is the 170 strike and he goes ahead and sells three of those at a price of $143 from a cash flow standpoint let's understand that what just happened was that for the right to buy our 300 shares of Apple at 170 at or before the options expired in March we were just paid $143 and remember each options contract represents that right to own 100 shares so we multiply that price by 100 and we sold three of them so when you multip reply it out we end up with $3,429 of positive cash flow if we move to the day those options expire we can see that Apple after initially rallying early in 2022 began to sell off and by March 17th the day that these options cease trading the stock had dropped to about 160 resulting in the call options expiring worthless and so the trader just Pockets his 3,429 of covered call Premium and then he basically reloads again selling three of those same 170 calls this time expiring in June 3 months later okay now updating our income chart for the June calls we just sold you could see that that brought in 1905 and again moving to the day those stopped trading Apple had sold off down to 13156 and so updating our campaign progress you can see that we've now collected $533 and so doing doing the exact same thing selling the 170 calls as soon as the previous ones expired for the final two quarters of the year the resultant profit as you can see was $654 and you'll notice that the final two quarters didn't bring in that much income Apple was trading well below 170 most of that time and so the calls that were sold were trading for a much lower value and so that slow methodical approach is certainly a hell of a lot better than the $273 you would have made simply collecting the Apple dividend paid in 2022 and I'd also like you to take note of the fact that this approach pays you a kind of a supplemental dividend four times a year just like you paid your normal corporate dividend four times a year okay so obviously that's a vast Improvement but there's actually a far more effective technique for selling covered calls and that is to close them early in in some cases way earlier than letting them simply expire and so if instead of waiting until the call options expire suppose that instead we wait until they shrink down to about 10% of their original value at which point we buy them back and then reload shortly thereafter regardless of how quickly that buyback actually happens in other words we don't wait for them to expire every 90 days like the technique we just described and that difference closing the trade earlier when most of the value has been realized is the key to this approach so let's see how this works so let's start again using this second technique selling the calls and later buying them back and we start the same way we did before selling those three at 170 expiring in March the exact same trade except this time instead of waiting until calls expire in March we instead watch the price of the call as it fluctuates depending upon what is happening with the stocks price and as you can see on February 24th Apple had a huge gap down opening at 15294 and so when a stock drops like that so precipitously it pulls the call options price down with it and so by that morning the call Price had shrunk down to 69 cents and so if instead of allowing it to expire worthless we simply bought it back for that low price of 69 cents then our cash flow situation would look like this with a profit from the marsh calls of 3,222 which is actually less than we made from the March calls in the first approach where we just let the calls expire and pocket the premium so you might be asking well how's that going to help us if this new technique causes us to make less money on that first transaction how's that maximizing our profits well let's see how this unfolds and that question is going to answer itself so if we wait just about a week to March 2nd you'll see that Apple bounced after that initial gap down a week earlier resulting in the stock climbing back to over 166 well if you think about it if the stock bounces that's going to make the value of the calls go up as well and so instead of selling the June calls like we did in that previous approach we sell the May calls because we've now closed the first call so we can move the process up a month we don't have to wait for the June call to expire we can sell the May calls now instead and in this case we sell those for as you can see $85 which then adds $2,415 to our cash flow and then if we move ahead to May 3rd 17 days before the May options expire we see that Apple again sold off to below 160 and when we take a look at the options chain we see the opportunity to again closed the May position early for about 10% of the original price we sold the calls for and so we'll again update our cash flow table for this buyback of the May calls so rather than run through each example which would be a little tedious for you instead we've created this table which summarizes the year using this new approach where we're selling the 170 calls and buying them back when they can be bought back for about 10% of what you sold them for no matter how quickly that happens and so you take the original credit you received you deduct from it the debit you paid to close it and that results in your profit we're also capturing in this table how long we were in each trade to demonstrate how often we're reloading to speed up the flow of cash into our account as compared to the quarterly expirations they guarantee no more than four trades a year and so for example the July expiration trade was only 15 days because the stock sold off dramatically after the calls were sold allowing you to buy them back cheaply and quickly which was purely luck but that can happen and it will happen if you trade covered calls this way on the other hand we were never really able to get out of the August calls early and instead on the last day they traded we bought them back for a large debit resulting in a very small $60 gain and that also is going to happen and so when you summarize the results of the of the sell and buyback technique you get over $10,000 in options profit considerably more than the sell and expire approach in fact comparing those two approaches it's interesting because while the average profits per trade are only slightly Superior with the sell and buyback technique the big difference the big difference maker is the sheer number of possible trades which in this case was 50% more six trades versus four and that's because if you are reloading with a fresh three new calls much more quickly than with the sell and expire case where you can only reload once every 90 days you can make so much more money in a year as this is a vivid example of making 64% more than the robotic sell and expire approach this approach takes a little more work but the reward is obviously worth it okay so now we're ready to move on to the second way to optimize your covered call trading returns and that is by buying deep in the money calls instead of buying shares of the stock that you're interested in subjecting to a covered call campaign now to understand the point we're trying to make here let's use the example of a Gold stock some of you may know the shares of gold mining stocks are fairly highly correlated to the price of gold itself and so some Traders for different reasons prefer to trade the stock of gold mining uh shares as opposed to Gold Futures themselves and so let's take a look at a chart of just such a gold mining stock by the name of Franco Nevada corporation which trades under the ticker symbol fnv and what we're looking at here is its price chart from late January of 2021 through to late January of 2022 and as you can see fnv seem to find support right around that 125 level level and late in the previous year peaked out a couple of times at around the 150 level before it sold off and so let's say that a Trader has a thesis that this stock was going to continue to find support around 125 and most likely would not get past 150 very easily and he wanted to go long fnv because the stock was very close to that support level in January 28th of this year trading at 12717 midm morning well in that case then and if he had some conviction in this thesis he could buy a th000 shares of fnv at 12717 but that would cost him $127,100 which is fine of course unless you don't happen to have $127,100 in your account which of course is the case with many Traders just getting started out but what if there was another way for way less Capital to pick up almost the entire upside that you were looking for with a th shares but at a fraction of the initial cash outlay well let's take a look let's say that on January 28th of that year 2022 late in the day we went out to the options chain about three weeks later the February options chain and we went ahead and sold 10 of those 150 calls right up at where we think resistance may be and then at the exact same time we move out to the options chain about 6 months out the July chain and we buy 10 10 of the 100 calls what options Traders refer to as deep in the money calls because the stocks trading at a much higher price than the strike price of those calls so what he's done is to create what options Traders refer to as a synthetic covered call and you'll see shortly why he would have done something like this in the meantime let's track the cashlow of what's happened so far and as you can see the trader paid a price of 2930 for the calls and each call option represents 100 shares of stock so you multiply that by 100 and we bought 10 of them and so the total he paid was $29,400 for those and in turn he sold the 10 calls expiring in February for 38 cents which as you can see from the calculation would have caused a cash inflow of $380 to his account resulting in a net price of 28920 okay so now let's fast forward to the day those short 10 calls expired in February and as you can see FNB closed at 14777 which means that those short 150 calls expired worthless that day as we explained earlier and so what is often done in these cases is that the trader will reinstate his short call position on an options chain a month later and so he'll go ahead and sell 10 of the March 150 strike price calls this time for a lot more 477 because the stock won't have to move up very much further for that call to have value so the market charges more for that and as you can see now the overall cost of the synthetic covered call campaign is now even lower after subtracting out the credited from the March calls as you can see so the total cost is down to 24150 as you can see from the calculation okay so let's move forward to the day those March calls expire on March 18th and as you you can see fnv closed at 15434 that day and so that's above the strike price of the 150 calls and therefore on expiration the trader would be required to sell 1,000 shares of fnv to the one he sold those calls to for $150 a share so instead of going through some other gations most Traders just would go ahead and close the position at this point and so if he did that at the end of the day when the stock was trading at 15460 let's see what the outcome of the trade would be starting with those July deep in the money 100 calls those could have been sold for around 5460 that day because let's compare the two trades apples for apples on the one hand buying the shares outright and on the other hand implementing the synthetic covered call campaign that we just shared with you and as you can see as we mentioned earlier the original shares would have cost 127,128 couldn't afford whereas the synthetic covered call program cost was never more than 28,9 120 and actually came down as we added the sale of the March calls and now from a profit standpoint buying and selling the shares at the same time we closed the options trade would have yielded a profit of 27,43 while the covered call approach actually outperformed it making in excess of $30,000 and so obviously the returns are going to be dramatically different with the share results showing a return of 21.56% which is good versus a return of 10.29% for the pure options trade and so it should be pretty obvious that the synthetic covered call strategy the pure option strategy has the potential to hugely improve the return potential of your covered calls and so this approach should be examined each time you're considering a covered call Trade to see if buying the deep in the money calls would make more sense than flat out buying the shares as they clearly did in this case now we're going to cover the third and final key to maximize your trading profits using covered calls and that is this when looking for the right location for selling your covered call always locate that call at your price target for that stock or you're going to regret it now why will you regret it well let's take a look at a vivid example and you're going to see exactly why okay so let's head back to the beginning of the year and as you can see Tesla stock had taken a beating pretty much throughout all of 2022 dropping from its high of 40267 to just a hair over 100 more than a 75% drop and then in early 2023 the stock began to bounce and by January 20th had rallied up to 12789 and so suppose that a Trader had become bullish on that day and through his analysis reached the conclusion that it was very possible that Tesla could at least get back to 50% of its 2022 high at 200 by mid year that shouldn't be too much of an ask and so suppose that a Trader who bought 100 shares of Tesla on January 20th suppose that he pull up an options chain expiring in July of 2023 6 months later and he looked at the call options that were out of the money which is basically everything above 130 and he noticed as you can see that the option with the highest price was in fact the 130 option with a price of 2375 as you can see and so suppose that he said to himself well hey I should just go ahead and sell that 130 call option after all it's got the highest price and so if he were to have gone ahead and done that as you can see he would have received 2375 okay so that's a lot of money and that's great but remember I told you there's a catch here so we're also going to look at the same basic idea guy wishing to sell a covered call on his 100 shares of Tesla but in this case instead of selling the most expensive out-of-the-money call we went ahead and sold the call that was located at our price target of 200 well as you can see that's trading at a considerably lower price at 572 which therefore would mean that we'd only bring in $572 so why would we choose the one which pays us less than the 130 call which paid us over $2,300 well let's fast forward now to July 21st the day the call options expired as you can see Tesla rallied and closed well above 200 so we were actually not nearly as optimistic as we should have been with our price Target but nonetheless we were right the stock was due to rally and it blew right past 200 up to 260.05 7.89 he only made $211 per share from the shares themselves which on 100 shares is $211 and he made so little because his acquisition price was so close to the call strike price that when he was forced to sell them he hardly made anything on them now of course you add to that the nice premium he got for selling the call but when you add those two positive together the total profit is 2586 whereas the guy who sold the call at his Target for Tesla the the 200 strike he made a boatload on the sale of the shares at 200 which as you can see from the calculation yield at $7,250 72 on the original call income but the total resulted in a amount of $ 7,783 which is triple what he earned on the covered call where the trer neglected to remember his Target price and just went for the juicier call income at the 130 strike if you have a substantial profit Target you're almost always going to cost yourself money sometimes like in this case a great deal of money by not locating your call strike price at your target profit and so what I'd like you to take away from today's video is that while covered calls are a solid way to enhance your trading income and investment returns if you employ the techniques that professional Traders use to boost the Returns on their covered call trades like the three tips that we've shared with you in this video you would be in a great position to substantially increase your Returns on covered calls whether you're an investor of your own capital or a Trader of firm Capital like the professional options Traders on our desk here at SMB now if you'd like to learn three more option strategies that our prot Traders use including the unique options trick that allows you to make money while while you wait to buy stocks or ETFs at the price you want and the options income strategy that allows you to make consistent money whether the market goes up down or sideways and how to make money on a stock or index trade even if you're outright wrong on the direction then click the link that should be appearing now at the top right corner of your screen that will open the free Workshop registration page in a new window so don't worry you won't lose this video or you can register directly for free at op options class.com believe me you don't want to miss it so sign up now before it's too late

Channel: SMB Capital

Views: 201,458

Keywords: stock market, day trading, smb capital, trading, investing, markets, wall street, stock trading, options trading, options income, economics, finance, covered calls, options trading tips, covered call options, options covered calls

Id: U8gFC00kZ58

Length: 24min 12sec (1452 seconds)

Published: Thu Oct 12 2023