How to Execute a Covered Call Trade with a Buy/Write Combination Form – March 29, 2021
Covered call trades can be entered by legging-in (2 separate trades) or via the buy/write combination form (1 net trade). When available, the latter is an effective, and perhaps cheaper, way to execute our covered call trades when the bid-ask spreads of our options are narrow. This article will explain how to use the combination form using a real-life example with Corcept Therapeutics Incorporated (NASDAQ: CORT), a stock on our premium stock watch list on 9/8/2020.
Initial trade structuring
On 9/8/2020, CORT was trading at $19.98 and the 10/16/2020 $21.00 call showed a bid-ask spread of $1.35 – $2.20. Leveraging the Show or Fill Rule, we will seek a bid premium of $1.70 for a 5-week expiration. Here is the option-chain for CORT on 9/8/2020:
Initial calculations with the multiple tab of the Ellman Calculator
Legging-in
- Place a market order to buy 100 shares of CORT
- Once executed, place a STO (sell-to-open) limit order for 1 contract at $1.70
Buy/write combination form
- Go to buy writes & unwinds (titles may vary slightly from broker-to-broker)
- The net debit limit order is set at $18.28 ($19.98 – $1.70)
- Day only: if not executed, we re-evaluate the next trading day
- Review and confirm order
- Once executed, place a buy-to-close limit order on the option side based on our 20%/10% guidelines ($0.35 or $0.15)
Discussion
Covered call trades can be executed by legging-in or with a buy/write combination form. Both are acceptable with a possible slight advantage to the latter when the bid-ask spread is small. Legging-in may be a better approach when the spread is wider so we can leverage the Show or Fill Rule.
Author: Alan Ellman