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  • Converting a High Risk to a Low Risk Covered Call Trade – January 20, 2025

    Jan 20, 2025 Uncategorized 0 comment

    High implied volatility securities can be used in covered call trades in a defensive manner using the appropriate call strikes. In this article, Neurocrine Biosciences, Inc. (Nasdaq: NBIX) will be used to analyze the conversion process.

    NBIX data on 8/15/2024 from the BCI Premium Stock Report

    • Industry rank: A
    • Media Analyst Rating (MAR): 1.80
    • 7 weeks on BCI “eligible” list
    • Initial time-value return goal range for a 1-month expiration is 2% – 4% (as 1 example)
    • Implied volatility (IV): 75.6% (extremely high and risky)

    The concern is the high IV which represents substantial risk to the downside.

    Converting a high-risk to a low-risk trade

    By opting for an in-the-money (ITM) strike, the intrinsic-value component of the premium will lower the breakeven (BE) price point substantially.

    NBIX option-chain data on 8/15/2024 with NBIX trading at $146.70

    • $155.00 OTM strike: $11.00 premium (BE -breakeven- at $135.70)
    • $125.00 ITM strike: $25.30 premium (BE at $121.40)
    • Strikes in the $170.00 – $180.00 range generate 2% – 4%

    Pros & cons of the OTM strike

    • 2 income streams possible if share price rises
    • Higher breakeven price points than ITM strikes
    • Significant initial time-value returns

    Pros & cons of the ITM strike

    • Significant initial time-value return
    • No upside potential if share price rises
    • Lower BE price points
    • Intrinsic-value acts as an insurance policy, paid for by the option buyer

    Deep ITM initial calculations resulting in meaningful downside protection

    • Yellow cell: BE price point is $121.40, compared to current market value of $146.70 (green arrow)
    • 37-day return is 2.88%, 28.41% annualized (brown cells)
    • Downside protection of the time-value profit is 14.79%
    • Calculations achieved with the BCI Trade Management Calculator (TMC)

    Discussion

    Using deep ITM call strikes can convert high-IV and high-risk trades into low-risk trades, while still offering significant initial time-value potential returns.

    Author: Alan Ellman

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