Stock Guarantee Strategy (Covered Call): How to Hold Shares “Rent” Under Cross-Line Trading

[Case Background]

TUTU is a Nasdaq-listed banking company (non-real stock, for use only as a case demonstration), with its sound financial management and innovative financial services model, Option Sir remains optimistic about its future development.

However, panic continues to spread in the markets after Silicon Valley Bank and Signature Bank both declared bankruptcy. Investors are worried about whether the banking industry will face a new round of crisis, an issue that is becoming a hot spot in the market. AS A RESULT OF THIS VOLATILITY, OVERALL MARKET SENTIMENT DECLINED, LEADING TO A GENERAL DECLINE IN BANK STOCK PRICES, INCLUDING TUTU.

While Options Sir remains optimistic about TUTU's long-term prospects, he recognizes that it may be difficult for TUTU's share price to rise significantly in the short term under the influence of current market sentiment. At the same time, as a rational investor, he is also aware that holding stocks comes at a cost of time and wants to be able to earn extra returns with some strategies.

For this market environment, Option Sir has built a stock guarantee strategy (Covered Call).

Under the premise of holding TUTU shares and selling a Bullish Option (Call), i.e. sell a Stock Guarantee Call, you can earn extra income for yourself while dealing with the risk of a collision.

【Strategic Composition】

“Buy Common Stock” +“Sell Call”

Number of Positions Holding = Number of Shares Corresponding to Sell Call

(Note: In this trade, the shares held on hand provide a guarantee of the option being exercised in the future.)

【Applicable Scenario】

Based on this, we discuss further: consider “Buy a positive stock, sell a call” separately.

“Buy a positive stock”: This is actually part of a stock transaction. Just looking at this trading behavior indicates that you see more about the right stock price.

“Sell Call”: This is only part of options trading. Just looking at this trading behavior indicates that you are not looking at the right stock price.

Therefore, the covered call strategy is suitable for looking at a positive stock trend in the long term and determining that the price of a stock will not rise in the short term.

(Note: This strategy is more suitable for investors who want to hold long-term stocks, not investors who want to do short-line volatility.)

【Position opening operation】

“Buy Common Stock”

Buy 100 shares of TUTU stock at a cost of $50 per share and a total purchase cost of $5000.

“Sell Call”

Sell 1 Call (line option price $55, contract multiplier 100, expiration date 2023.04.22, option fee $5) and collect options $5*100=$500.

So, a covered call strategy is in place.

[Profit and Loss Analysis]

Out-of-price situation: If the expiry date of 2023.04.22, TUTU's share price is <$55, the option is off-price.

At this time, the buyer will not exercise rights. Option Sir collects the option money and does not have to fulfill the obligation to sell TUTU shares.

First, calculate the profit and loss balance point to analyze the subsequent situation:

Profit and Loss Balance Point = Buy Share Price - Sell Call Options = $50-$5=$45.

Then, divide the strategy into two parts of profit and loss, namely the “Sell Call” gain and the “Buy Common Stock” gain.

Earnings on Option Sir = Proceeds from Selling Call+Gains on Buying 100 Shares of TUTU Shares

When TUTU stock = $45, the yield of Sell Call is $500, and the yield of 100 shares of TUTU shares is -$500, the total return of the strategy is $0.

When $0＜TUTU Stock＜$45, the strategy will lose. Among them, the loss is greatest when TUTU stock = $0. The yield of Sell Call is $500, the yield of 100 shares of TUTU shares is -$5000, and the total income of the strategy is -$4500.

When $45＜TUTU Stock＜$55, the strategy will be profitable. For example, when TUTU shares = $50, Sell Call yields $500, and 100 TUTU shares yield $0, the total return of the strategy is $500.

In-price situation: If the expiry date of 2023.04.22, TUTU's share price is ≥$55, the option is within the price.

At this time, the buyer will exercise the right. Option Sir, in addition to receiving options, is required to fulfill an obligation to sell 100 shares of TUTU stock for $55.

We continue to divide this strategy into two parts, for profit and loss, respectively.

Earnings on Option Sir = Proceeds from Selling Call+Gains on Buying 100 Shares of TUTU Shares

When TUTU shares are ≥$55, because the Sell Call is in the price, there is actually a loss on the Sell Call section if you do not take into account the option money received.

But since the initial withdrawal of option funds reduces the cost, the calculation shows that only the “Sell Call” part of the “Sell Call” will be lost at the TUTU share price of ＞ $60.

As TUTU's share price continues to rise, option Sir is profitable on the “Buy Common Stock” section.

With one gain, two parts added up, whether TUTU shares rise to $100 or rise to $200, the strategy has a constant total maximum gain of $1000.

(Note: All of the above profit and loss data are based on theoretical maturities and do not include transaction fees. (In actual trading, both expiry options can be closed mid-way, and actual profit and loss will vary depending on your trading behavior.)

【Strategic Features】

In this strategy, “Buy a positive stock” is the main position and a “sell call” is a hedge position, and the profit and loss situation depends mainly on the upside of the positive stock.

The strategy has the following characteristics:

• Increased additional earnings, hedging stocks fell

  The “Sell Call” part earns option money income, which reduces the cost of holding positions and reduces losses compared to buying the shares separately.
  If the price of the shares falls, the loss of the single holding is reduced due to the income from the additional option funds.

• Sacrificing profit space for rising stock prices

  However, once the “Sell Call” part is selected, it actually changes the closing price of the positive stock.
  When the stock price reaches the stock option price, it is sold for profit, and the positive stock price continues to rise, and it has nothing to do with you.

• No Margin Required, No Strong Level Risk

  When options sellers open a position, a certain margin is generally required.
  However, the strategy has sufficient equity as a guarantee, does not pay extra cash margin and there is no risk of forced closing.

【Tips】

• Selection of the number of contracts

  The number of shares corresponding to the Sell Call = the number of positive shares held. If the corresponding number of positive shares in a Sell Call is equal to a Bare Call, the risk is unlimited.

• Choice of Expiration Date

  In general, if you do not take into account other factors, the closer the expiration date, the faster the time the option loses value, the more favorable it is for the option seller.
  At the same time, the closer to the expiration date, the lower the option royalty. So, everyone needs to choose the right due date based on their own predictions and strategies.

• Choice of Line Option Price

  Experienced investors will usually set the Sell Call's line option price as their preferred selling target price.
  This way, even if exercised, you can sell the shares at your expected price and gain an additional royalty.

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