Covered Calls

Selling Covered Calls Out of the Money

Situation - A forex options trader owns a spot position in the GBP/JPY (for simplicity 1 regular lot) that you bought at 211.00. The pair has moved up 200 pips but is stalling at resistance at 213.00 you think it will stall for a week or so then continue higher but you want to profit from this situation.

Action - Sell a covered call at a strike price of 213.00 out 7-10 days to expiration, estimated premium would be about 2.00 which means:

You are currently up about 200 pips on your spot position so this is $2000 in profit ($10 payout for simplicity), you get a premium of 2.00 which is another $2000 in profit. You just doubled your profit and are now guaranteed $4000 in profit if the GBP/JPY continues higher or stays just below 213.00.

After you sell the calls out of the money there are three possible outcomes:

First possibility - The GBP/JPY consolidates below 213.00 for a couple of days but continues higher (into the blue area on the image below)) and you take no further action in your account. Your profit limit has a ceiling of $4000, if the GBP/JPY spot position continues higher you cannot profit from this and you are called out of your spot position at expiration. Maximum profit is $4000. Called out means that your GBP/JPY spot position will be removed from your account after expiration, you no longer own the GBP/JPY spot position after expiration, you were called out.

In the image above the yellow area is out of the money and the blue area is in the money.

Second Possibility - The GBP/JPY drops unexpectedly, so you need to know your break even point because you own a spot position. Break even calculation, you bought the GBP/JPY at 211.00 and it is at 213.00, which is 200 pips of profit ($2000) after you sell the calls your breakeven price goes from 211.00 to 209.00. The selling of the call protects you by an additional 200 pips. You can install a price alarm and stop order at 209.00 to notify you of the price drop and subsequent liquidation of your spot position, you can also buy back your calls at that point.

Third Possibility - If the GBP/JPY tays below 213.00 (stays in the yellow area in the image above) until expiration then starts to rise you keep the $2000 premium and additional profit from the GBP/JPY spot position rising. Your cost basis is now 209.00 and the trade it can get extremely profitable here.

You can also do the exact opposite of this trade and sell covered puts. In this case you would be selling the GBP/JPY then selling a covered put out of the money in a profitable sell position.

Selling Covered Calls In the Money and Buy-Writes

Situation: You are a little late coming to the computer for the main trading session but the GBP is strengthening across the board and is starting a new move.

Action: Buy 1 regular lot of the GBP/USD at 1.9800 and sell covered calls at a strike price of 1.9750 for two weeks out. Estimated premium is 90 pips. $900 goes into your account. Check quotes it could be slightly lower. By comparison selling calls at 1.9800 would give you a $600 premium. In the image below the yellow area is out of the money and the blue area is in the money.

After you sell the calls out of the money there are three possible outcomes:

1. The GBP/USD continues higher, you keep $400 net premium.

2. The GBP/USD goes sideways but stays above 1.9750. You keep $400 premium.

3. The GBP/USD unexpectedly drops significantly to below 1.9710 which is break even price. You could set a price alarm at 1.9720 and a stop order at 1.9710 for your spot position which is break even on the deal. If the GBP /USD keeps dropping you break even. Break even is 30 pips higher if you had sold calls at 1.9800.