How to Write Covered Call Options – A Step by Step Guide
We had an article here in the past that explained the basics of how call option writing works, but we never got into the mechanical details. As the reader questions continue to pile up and the markets becoming more volatile, the question of how to write a covered call option with a discount brokerage account is becoming more common.
I’ll be honest in admitting that I’ve only written a few covered call options, mostly for experimentation purposes. Even though I’m not an expert options trader, I can explain the details on how to write a covered call with a regular discount brokerage account.
Before we get started, lets explain what exactly a covered call option is. As options are a fairly advanced investment strategy, they should not be taken lightly. A covered call option is when you own the underlying security, and you sell the option for another investor to purchase at a specified price. The call option buyer pays the seller/writer a premium for the option to purchase the stock in the future. If I were to use the casino analogy, the call option “seller” would be the house as most options are never called away.
How to Write a Covered Call Option
As the last couple option trades that I made were with Questrade, I’ll step through the process with their interface. Although this description may be specific to Questrade, it should be very similar to other interfaces (at least it is with CIBC and iTrade).
Pick a Security to Option
Lets assume that you have an equity that you are willing to write a call option against. Ideally, it’s an equity that you’d sell at the strike price anyways and not fret if it gets called away. For example, in this case lets assume that you own at least 100 shares of Suncor (SU), and it’s getting close to the price you’d like to sell it anyways. As one option contract equals 100 shares, you’d be able to write one covered call on Suncor.
Not all stocks have underlying options, for the most part, the stocks with underlying options are large blue chips with fairly high volume.
To start, you’ll want to go to the “options” portion of your interface. With Questrader Web, it’s the “Trading Centre” tab -> “Options”. From there, you’ll see this form on the right side:
If you’ve made any trades before, the form above shouldn’t be too intimidating. Here’s an article on how to read traditional stock quotes which includes bid/ask explanations.
Symbol: The symbol is straight forward, which is simply the stock symbol for the underlying stock that you want to trade options with.
In this example, I used Suncor which is traded on the TSX. From there, click the magnifying glass to get the options quote and options symbol which brings up the table below. Simply click the “trade” link for the option that you want to trade and it will automatically populate the order entry field. Read further down for details on how to decipher this table.
Reading the table: Options expire every third Friday of the month, which is the contract date above. In this example, I chose the June expiry which displays corresponding quotes for each option available. Referring to the table, everything above the $38.57 shaded line is “in the money” while everything below is “out of the money”. The more “in the money” the trade, the higher the premium that option seller will receive. The further the strike price is “out of the money”, the lower the premium but the less likely the option will be called away.
If I choose a $40 strike price, this means I’m willing to sell my Suncor stocks for $40 providing that the option buyer pays me a premium of $90 (ask price x 100) per option contract. If Suncor closes higher than $40 on June 18th, it is likely that my position will get “exercised” thus called away. At that point, it’ll be the same as if I sold 100 shares for $40 plus whatever I collected as a premium. However, if the stock closes lower than the strike price, then the option will simply expire and I get to keep my shares (and the premium!). At that point, I’ll likely rinse, repeat and continue collecting premiums.
#Contracts: One contract equals 100 shares of the underlying stock. So if you own 200 shares of Suncor, but you only want to write an option against 100 shares, then put 1 in this field.
Limit Price/Order Type: I personally always use limit orders to prevent surprises when buying or selling. You can see from the table above what the bid/ask prices are for each option. Note that the bid is what the buyer is willing to pay, while the ask is what the seller is willing to sell for. Both prices will likely fluctuate so it’s best to set your price close to the going rate and let it happen. Stops are typically used to automatically sell a position should it fall to a pre-determined price.
Transaction: This is where some investors can get confused. For call option writing, the option to choose is “Sell to Open“. This simply means that you are selling the option to open the position. If you want to buy back the option that you sold, or buy any option “long”, you choose “buy to close”.
Duration: This is the duration that the order will remain open if not executed immediately. Day will keep the order open until the end of the trading day and Good Till Canceled (GTC) will remain open until manually canceled.
Preferred ECN: Most of the bank brokerages do not allow ECN to be chosen. Even if they do, I always leave it on auto. Brokerages like Interactive Brokers will charge extra if the Auto/Smart ECN routing isn’t selected.
AON: This stands for All or None, which means if you can’t trade the number of shares/contracts that you indicate, the trade will not execute.
This concludes the very basics of selling/writing call options with an online stock broker. If you have any questions, or anything to add, please leave them in the comments.