Covered call writing is a low-risk, cash-generating strategy. We can lower the risk to an even greater extent by purchasing protective puts and by writing in-the-money (ITM) call options. Now, buying protective puts (called the collar strategy when used in conjunction with covered call writing) costs money and will lower our returns. Using ITM calls will reduce risk but eliminate the opportunity to generate profits from share appreciation. All strategies have their pros and cons. In this article we will compare the two risk-reduction strategies using a real-life example with Centene Corporation (NYSE: CNC).

 

CNC 1-month option-chain on 4/16/2020

 

CNC Option-Chain

We will calculate the following strikes with CNC trading at $71.27:

Collar

  • OTM $72.50 call ($3.90)
  • OTM $65.00 ($2.55) and $67.50 puts ($3.20)

ITM calls

  • $65.00 ($8.50) and $67.50 ($6.80) ITM calls

 

Collar calculations with the BCI Collar Calculator

 

CNC Collar Calculations

  • Red arrows: 1-month and annualized initial time-value returns
  • Blue arrows: 1-month and annualized returns if share price moves up to OITM call strike
  • Green arrows: 1-month and annualized returns if share price moves below the OTM put strike

 

Selling ITM call calculations with the Ellman Calculator

 

CNC Calculations with the Multiple Tab of the Ellman calculator

  • Initial time-value returns range from 3.4% to 4.5%
  • Downside protection of those time-value returns range from 5.3% to 8.8%
  • Breakeven prices range from $62.77 to $64.47

 

Discussion

Risk reduction for our covered call trades can be accomplished in several ways. Two such approaches include buying protective puts and writing ITM call options. The former will protect against all gap-downs below the put strike but will cost money. The latter is paid for by the option-buyer in the form of intrinsic-value but will eliminate the opportunity to generate additional profit from share appreciation.

 

For more information on the collar strategy

BOOK

ONLINE DVD PROGRAM

COLLAR CALCULATOR

 

Investment club program board members

If you would like to schedule a private webinar with Alan and Barry, send an email to:

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Include:

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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 share some of these testimonials in our blog articles. We will never use a last name unless given permission:

Hi Alan,

I have gone through the 2 covered call books and the DVD set. I must say excellent compilation of material. It is as simple as ABC and played out excellent. The pace of the course is just fine so that it is not overwhelming.

Best regards,

Randy

 

Upcoming event

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February 9, 2021 at 7:30 PM ET

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3. AAII Research Triangle NC

April 10,2021 at 10 AM ET

 

Alan speaking at a Money Show event

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