Choosing The Best Strike Price To Sell Covered Calls
This is an article I’ve been meaning to get to for quite a while now. Today, I’m finally going to show you how to find the best strike price to sell covered calls.
Covered calls can be a great way to generate income through earning premiums. Today, I’m going to show you how to do it like a pro. I’ll be using an example of a trade I made earlier this week to show you how I choose which strike price to use.
Let’s get to it!
TPR Stock Trade: Selling Covered Calls
Okay, so below is an image of my account with the stock Tapestry (TPR). This is the stock I was trading earlier this week.
As you know, I love to trade using the Wheel Strategy. With Tapestry, at some point, I got assigned the shares which is Step 2 of the strategy. So what happens after I get assigned shares? That’s right, we come to Step 3 of the Wheel Strategy: selling covered calls.
I’ll go into more detail about being assigned these TPR shares in a minute, but I ended up having to buy 2,700 shares at $37.00 per share.
As you can see above, the price on the day I traded TPR was $36.19. This means I can sell covered calls against my existing position of 2,700 shares. So which strike price should I use?
This is always another question I wrestle with every time I sell an option. Should I sell the calls at the ATM, at the money, strike price? This means a strike price of $37.00 or $38.00. Or should I even go a little higher and sell the $39.00 call?
Choosing The Right Strike Price
Let’s take a look at each price and discuss the pros and cons. After that, I’ll tell you exactly what I did for this trade.
I always refer back to my calculator here to determine which strike price is the most beneficial for my trade.
Okay, let’s talk about this first situation. The stock purchase price is $37.00, the expiration date is just a few days from now on Friday. When I recorded this trade it was August 23rd, so just a four-day trade until the options expire on August 26th. This is an important detail, and I’ll explain why.
So with 2,700 shares of TPR, let’s start with choosing the strike price of $38.00. I’m not selling these ATM, I’m selling one price level above. What are the pros and cons of this?
To start, I can get about $0.15 in premium, which means that I would receive a total of $405 in premium for the trade. Over the course of four days, that means I would make $101 per day.
But what about the alternative?
If I sell these calls at a strike price of $37.00, which is the price I got assigned, I would make around $0.30 in premium.
So let’s plug this into the calculator.
$0.30 is a nice premium because it is double what I would make for the $38.00 call. I don’t even need a calculator for this one: $405 x 2 = $810 in premium or $202 per day.
In just four days, why wouldn’t I go for the $37.00 strike price and maximize my premium?
It’s Not Just About The Premium
The difference here is that if I’m selling calls one strike price level above the ATM price, I can potentially make money by selling the stock too.
Let me explain. I was assigned these shares at $37.00. If my $37.00 calls get assigned then I am earning a premium of $810, but I am not making any money from selling the stock.
If I bought them for $37.00 and I end up selling them for $37.00, I make zero money on the stock. I do get to keep the $810 in premium though!
But if I sell the $38.00 call, then this means I bought the shares at $37.00 and can sell them at $38.00, if the stock closes above $38.00 by Friday.
If this happens, then not only do I make the premium of $405, but I also make an additional $2,700 because I make $1.00 profit for each share that I own.
So I can either make $810 guaranteed, or $405 plus a potential $2,700.
Before I go into the details of what I did, let’s take a look at what the chances are for TPR to move above $38.00 in four days.
TPR Stock Analysis
Right now, at the time of writing this article, the stock is trading at just over $36.00. We’d need a move higher of about $2.00 in four days. If we calculate a move of about $1.90 to $2.00, divided by the current share price of about $36.00, we’d need about a 5.0% move higher.
That’s not that much of a move for TPR. On the 23rd alone, the stock was higher by 2.0%. As you can see, it was up as high as 3.0% as well. A 5.0% move is absolutely in the realm of possibilities by Friday.
Now, what about the $39.00 strike price? If the $38.00 strike price is within reach, why not try for the $39.00 strike price?
So let’s plug it in here. All of the data is the same except for the $39.00 strike price and the premium.
Okay, so the Bid is $0.05 over $0.10, so let’s calculate with a mid-price of about $0.05.
So now we’d only make $135 in premium. But, if TPR was to go to $39.00 by Friday, I’d make an additional $5,400 for this trade. This is $2.00 of profit for each of the 2,700 shares I own. That brings this total potential profit to $5,535.00.
Okay, so now to calculate what chance TPR has of reaching $39.00 by Friday. A move to $39.00 would be about an 8.0% move to the upside. In four days, that’s a bit of a stretch to me. While $5,535.00 would be incredible, it just doesn’t seem likely to happen by Friday.
So my calculator was actually already showing me the best trade to make. In the green here is my sweet spot.
I should choose the $38.00 call where I receive the $405 in premium, plus the potential to make $2,700 more if the price moves higher by 5.0%.
And that’s exactly what I did!
Summary: Choosing The Best Strike Price To Sell Covered Calls
This is how I find the best strike price for selling my covered call positions. If you like trading covered calls, you’re going to love trading with The Wheel Strategy.
The Wheel Strategy allows you to buy these stocks at a discount, with an even bigger potential return than just selling covered calls.
Curious about this strategy? Don’t worry, I made an exclusive video for you to check out HERE.
I hope that this article on how to find the best strike price to sell covered calls was helpful!
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