There are 2 major ways to protect the investment inherent in our covered call trades. On way is buy protective puts and convert the covered call trade to a collar trade. We must pay for this type of trade insurance. The other is to sell in-the-money (ITM) strikes, which have an additional intrinsic-value to the premiums. This form of insurance is paid for by the option buyer and free to us, the option seller. This article will analyze the benefits of ITM call strikes when taking defensive approaches to our covered call trades.
Option premium formula
Total premium = Intrinsic-value + time-value (extrinsic-value)
- Intrinsic-value (IV) applies only to ITM call strikes (lower than current market value)
- IV is the dollar amount the strike is lower than current market value
- At-the-money (ATM) and out-of-the-money (OTM) strikes consist of only time-value
- If a stock is trading at $48.00 and the $45.00 ITM call sells for $4.00, $3.00 is IV and $1.00 is time-value
- Because ITM strikes contain an IV component, the breakeven (BE) price points are lower than those for ATM and OTM call strikes
- This can be viewed as additional insurance for our covered call trades and is paid for by the option buyer, not us
Real-life example with Broadcom Inc. (Nasdaq: AVGO): Option-chain on 9/26/2024
- 9/26/2024: AVGO trading at $178.33
- 9/26/2024: STO 1 x 10/25/2024 $170.00 ITM call at $10.90
- The BCI Trade Management Calculator (TMC) will break down the components of the trade premium
AVGO ITM covered call initial trade calculations with the BCI TMC
- The top section represents trade entries, and the lower section reflects spreadsheet calculations
- If the trade taken through contract expiration, this is a 30-day trade (lower left)
- The spreadsheet breaks down the premium into TV ($2.57) and IV ($8.33)
- The BE price point is $167.43 (yellow cell)
- The initial TV return is 1.51%, 18.39% annualized (brown cells)
- The downside protection is 4.67% (purple cell). This is our free insurance. It means that we are guaranteed a 1.51%, 30-day return, as long as share value does not decline by more than 4.67% at expiration. Intrinsic-value protects time-value, is another way to state this form of free insurance. This is different from the BE price point
Discussion
One of the many advantages of covered call writing is that we can leverage the concept of the money ness of the strikes to set up defensive trades where the additional insurance is paid for by the option- buyers, not us, the option-sellers.
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Your generous testimonials
Over the years, the BCI community has been incredibly gracious by sending our BCI team email testimonials sharing stories as to what our educational content has meant to their families. Moving forward, we have decided to publish several of these testimonials in our blog articles. We will never use a last name unless given permission:
Alan,
Upcoming events
1 Long Island Stock Investor Group Part II
March 13, 2025
7:30 – 9:00 ET
Private investment club
Cash-Secured Puts: 2 Outcomes
2. Money Masters Symposium Dallas 2025
Saturday April 5, 2025
Hilton DFW Lakes
Saturday April 5, 2025
Hilton DFW Lakes
2 events:
45-minute workshop
- Option basics
- The 3-required skills
- Practical applications
- Traditional put-selling
- PCP (Put-Call-Put or wheel) Strategy (adds covered call writing)
- Buy a stock at a discount instead of setting a limit order
All Stars of Options panel discussion
3. Money Masters Symposium Miami 2025
Thursday May 15, 2025
Details to follow.
4. BCI Educational Webinar Series
Using Cryptocurrency in Our Low-Risk Option Portfolios
Registration details to follow.
Alan,
In your Complete Encyclopedia you name the 4 technical indicators used in the bci methodology. My question is do you consider any more important than the others?
By the way, love the book.
Thank you.
Steve
Steve,
Of course, they’re all important but I’d give an edge to the exponential moving averages and volume.
We definitely want a favorable trend and want to be sure that volume confirms our bullish assessment. We also use volume to red flag negative volume divergence.
Glad you’re enjoying my book.
Alan
Premium Members,
This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member site and is available for download in the “Reports” section. Look for the report dated 02/21/25.
Be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them on The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:
https://www.youtube.com/user/BlueCollarInvestor
Barry and The Blue Collar Investor Team
Premium members:
This week’s 5-page report of top-performing ETFs, along with our sample trade of the week, has been uploaded to your premium site. The Select Sector SPDR section is now crafted to align with our streamlined (CEO) approach to covered call writing. The report also lists Top-performing ETFs with Weekly options, mid-week market tone as well as the implied volatility of all eligible candidates.
We have also included a sample trade taken from one of our BCI watchlists.
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https://youtu.be/EXMO-KwZuJs
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Alan and the BCI team
Hi Alan,
My strategy is cash secured puts. My brokerage is ETrade and only allows me to enter one order to exit a trade. It is either a buy back order when the option premium gets to the 20/10% amount of the original option premium with 2 weeks/1 week remaining to expiry, OR, a buyback order when that I place for when the price of the underlying stock price gets equal to or less than the stop loss price (3% less than strike price).
Which do you recommend and why?
Thank you.
Chris
Chris,
The 3% guideline protects us against share price decline and mitigates a losing trade.
The 20%/10% guidelines as they apply to cash-secured put selling, enhances gains when share price accelerates exponentially.
I would favor entering the 3% guideline and monitoring the trade if share price rises, such that we can change the broker order based on current trade status.
The reason: If given the choice of playing defense or offense, I prefer defense. This reflects my conservative nature and may not be right for every investor.
Alan
Thanks so much, Alan this makes very good sense.