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Covered Calls Explained | Covered Calls TD Ameritrade | PSTH Covered Calls Example - YouTube
Channel: Wolves Of Investing
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How to write covered calls on TD Ameritrade
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In this video, weāre first going to talk
about what is a covered call.
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Second, weāre going to talk about the benefits
of writing covered calls.
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Third, weāre going to talk about some of
the risks of writing covered calls.
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Fourth weāre going to over an example of
how to sell a covered call and how to close
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out a covered call position before expiration.
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And finally, Iām going to show you the results
from one of my covered call trades over the
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past few months.
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All this right after
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What's up everyone welcome back to my channel
Wolves of investing
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My name is Donnie Nguyen and iām the founder
of Wolves of Investing
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If youāre new, my channel is primarily about
investing in the stock market
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If you want to learn how to achieve financial
freedom through investing
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Be sure to click on that subscribe button
if you havenāt yet
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And before we get into it, please remember
to drop a like on this video if you enjoy it.
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as it truly helps out the channel.
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So without further ado, letās get right
into it
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What is a covered call?
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A covered call is one of the most basic options
plays you can do and I think that the best
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way to explain what a covered call is through
an example.
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Letās say you own 100 shares of stock that
you bought for $25.00 per share.
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For those of you who are brand new to options,
one options contract represents 100 shares
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of stock.
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So in this example, you paid a total of 100
x $25 = $2500 for those shares.
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Letās say you sell 1 covered call options
contract on those shares with a strike price
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of $26 that expires next week.
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And letās say that you were able to sell
that options contract for 40 cents.
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Because 1 contract represents 100 shares,
you collect 100 x 40 cents, which = $40.00
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by selling that covered call
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That $40 is called the options premium and
itās yours to keep. You can use that $40
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to pay down your mortgage, pay down your student
loan, or buy yourself a fancy dinner.
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Whatever you want to use it for, itās your
cash to keep.
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When that option expires, 2 things can happen.
If your option closes out of the money
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Meaning the stock is at or below $26.00 per
share, then youāll keep your shares.
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If your option closes in the money,
Meaning the stock is $26.01 or higher, then
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your shares will get sold at the strike price
of $26.00 per share
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Either way you get to keep the premium of
$40.
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What are some of the benefits of writing covered
calls?
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The main benefit is that youāre able to
lower the cost basis of your stock.
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For example, with our $25 stock, we paid $2500
for 100 shares
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But because we wrote a covered call, our total
cost of ownership is $2500 minus the $40 premium,
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so $2460, Itās as if we only paid $24.60
per share instead of $25 per share.
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This may not seem like a lot, but imagine
if you can repeat this trade over and over
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again. Pretty soon, you will have significantly
lowered your cost basis.
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The 2nd reason, of course it to just collect
regular income on your stock.
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Many stock options have weekly expirations,
so you can potentially collect premium on
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your stocks every week.
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So what are the risks of writing a covered
call?
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The first risk is that the stock closes well
above your strike price where youāll still
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be forced to sell your 100 shares at the strike
price.
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So in our $26 strike price example, if the
stock closed at $30.00 per share at expiration,
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youād still have to sell the stock at $26
and lose out on that extra $4 per share, or
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$400.
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So itās very important that you pick a strike
price that youāre comfortable selling the
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stock at in case it gets called away.
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Now you donāt have to wait for the option
to expire.
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What you can do in this case is to buy back
the option to close the contract.
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I try not to do this if possible because I
will be paying a much higher price to buy
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back the option and thus negate all of my
gains.
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So the only reason I would buy back my contract
in this situation is if something fundamentally
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changed that makes me think that the stock
can sustain its new higher price.
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The 2nd risk is that the stock tanks.
But that risk is not that big of a deal if
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you picked a stock that you planned to hold
long-term.
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In fact, if youāve been selling covered
calls on that stock, youāve been lowering
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your cost basis, so a decrease in the price
of the stock should hurt much less than had
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you not been selling covered calls.
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Alright so now letās walk through an example
on TD Ameritradeās desktop app.
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You can also use the mobile app or you can
use Think or Swim which is a free platform
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provided by TD Ameritrade for its customers.
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As you can see, I have 100 shares of PSTH
in my account.
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And if I go to PSTHās stock profile page,
I click on āOptions chainā
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The default view just shows options that are
near the money.
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I like to see all of the available options,
so I click the Range dropdown and change it
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from Near the Money to āAllā and then
click the āView Chainā button to refresh
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the page
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This view shows calls and puts.
The calls are on the left-hand side, so thatās
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what weāre interested in.
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Now for call options I normally like to stick
to expiration dates that are less than 30
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days
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So here we can see that it displays the number
of days until expiration and we can see that
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PSTH does have weekly options available
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So first Iām going to look at these options
that have 6 days until expiration
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Then I look for a strike price that Iām
willing to sell the stock for at the expiration
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And I look for the premium that I can expect
to make selling from the covered call
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Letās say that I chose a strike of $24.00
The bid is 10 and ask is 15 cents
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This means that the current market value is
somewhere between 10 and 15 cents
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Next, Iāll go out to the next expiration
which is 13 days just to compare the premium
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at the same strike price
And we can see that the premium for the same
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strike is between 30 and 40 cents
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So letās say that and Iād rather collect
the higher premium and I feel comfortable
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with the 13-day expiration
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So Iāll select that option by clicking on
the bid price of 30 cents to start my trade
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To sell a covered call you need to make that
sure the Action is set to āSell to openā
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which means that youāre selling a call to
open your trade
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Then select the number of contracts you want
to sell. In this example, Iām only selling
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1 covered call.
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I always use a limit order on options to make
sure I get the best price possible
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I usually place a limit order at the Ask price
and then I keep lowering it by a penny until
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it gets filled.
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So here I enter the limit price of 40 cents
and then I click Review Order
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And before I place my order I can review it
to make sure everything looks correct.
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So we can see that Iām selling to open 1
contract of PSTH call option that expires
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on June 25th 2021 with a strike price of $24
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And we can see that if my order is executed.
Iāll collect $39.35, which is just the 40
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cent strike price x 100 minus the 65 cent
commission
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And then just click Place order to place your
trade
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How do your close out your trade before expiration?
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So as you can see here, I have an open covered
call on PSTH
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To close it out, I would place a Buy order
on that options contract
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And the Action this time is Buy to close
Meaning that Iāll buy back the option to
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close out the trade
In this case, I try to buy it back as cheap
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as possible, so Iāll place a limit order
at the bid price
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And Iāll keep on adjusting my order up by
1 penny until it gets filled
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The bid is 5 cents and the ask is 15 cents,
so it should get filled for 15 cents or less.
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I usually try to close out my covered call
early as long as Iām comfortable with my
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profit so that I can turn around and sell
another covered call at a later expiration.
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My goal is to collect as much premium as possible
before the stock tanks or gets called away
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So finally in this video, I wanted to show
you how I was able to collect premium on my
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shares of PSTH over the past few months.
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Here can see that I bought 100 shares of PSTH
at $24.50
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Then I sold 9 covered calls on it
Almost every single time I closed out the
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covered call early
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My total profits on these covered class was
$343.74
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So my cost basis was $2106.26, so itās as
if I only paid $21.06
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Itās actually less because I started out
by selling a cash-secured put option, which
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is another awesome strategy, but Iāll save
that video for another time.
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PSTH is closed at $22.86 on Friday. But instead
of being at a loss, Iām still at a profit
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because of my covered calls.
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Alright so before you leave,
If you want to join the most awesome Discord
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community
Where we talk about SPACs and other stocks
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Check out my link in the video description.
Weāre over 500 members strong and it is
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absolutely free.
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And if you want more insights into my portfolios
or if you just want to support the channel
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Check out my Patreon. A link is also in the
video description.
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And as always a huge thank you to the awesome
Patrons that have already joined!
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Alright so let me know what you think about
covered calls
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Are you going to start trading them?
Drop me a line in the comments
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Be sure to leave a like on this video before
leaving.
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Thanks for watching and Iāll see you next
time.
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