Is Covered Call Writing an Option Zero-Sum Strategy? – October 2, 2023
Covered call writing is not a zero-sum strategy. Both the option-seller (call writer … us) and the call buyer can be successful. This article will provide a hypothetical example, demonstrating a scenario where both call buyer and seller end up with substantial 1-month returns.
Hypothetical covered call writing trade
- 9/18/2023: Buy 100 x BCI at $48.00
- 9/18/2023: STO 1 x 10/20/2023 $50.00 call at $1.50
- 10/20/2023: BCI trading at $52.00 on expiration Friday
- 10/20/2023: Take no action and allow exercise of the $50.00 call, selling shares for $50.00.
Calculations with the BCI Trade Management Calculator (TMC)
- Top row shows the initial trade entries.
- The 2nd row shows the trade to last 33 days, if taken through contract expiration (red circle).
- The breakeven price point is $46.50 (yellow cell).
- The 2nd row shows an initial return of 3.13%, 34.56% annualized, based on a 33-day trade (brown cells)
- The 2nd row shows an upside potential of 4.17%, if BCI moves up to, or beyond the $50.00 call strike (purple cell)
- The 3rd row shows that the option was allowed to be exercised and shares sold at the $50.00 agreed-upon sale (strike) price (purple circle)
- The 4th row shows a final cash return of $350.00 (red arrow) or 7.29% (blue arrow) for the 33-day trade.
Covered call trade from the option buyer’s perspective
- 9/18/2023: 1 contract of the BCI 20/20/2023 $50.00 call purchased at $1.50 per-share or $150.00 for the 1 contract
- 10/20/2023: With BCI trading at $52.00 at expiration, the $50.00 call option is valued at $2.00 of intrinsic-value + minimal time-value, let’s say $0.02 for a total sale value of $2.02 per-share, $202.00 per-contract
- Based on an investment of $150.00, the final result is a return of 135% for the 33-day trade
Discussion
Covered call writing is a strategy where both the call seller and buyer can be successful. Of course, there is risk from both perspectives and not all trades will turn out as favorable as this hypothetical, but many do.
Author: Alan Ellman