Welcome back! In this post, we will be discussing how to choose the right strike price when trading covered calls.
What is a Covered Call?
A covered call is an options trading strategy in which an investor writes (sells) a call option while simultaneously owning the underlying stock. The investor receives a premium for selling the call, but also agrees to sell the stock at the strike price if the option is exercised.
Why Choose the Right Strike Price?
Choosing the right strike price for a covered call can be crucial for maximizing the likelihood that our call will be in the money (i.e., the stock price will be above the strike price) when the option expires.
How to Choose the Right Strike Price
One way to determine the appropriate strike price for a covered call is to use standard deviation as a guide. Standard deviation measures how much the price of a stock is likely to fluctuate within a certain time frame. By calculating the standard deviation of the stock and using it to determine the range in which the stock is likely to fluctuate, we can choose a strike price within that range to maximize the likelihood that our call will be in the money.
For example, let’s say we are trading a 39-day covered call on Nike, which is currently trading at $105 per share. If the standard deviation of Nike is 10.89 points, we can estimate that the stock will be between $95 and $115 about 68% of the time. In this case, we might choose to sell a covered call with a strike price of $115 or $120 to maximize the likelihood that our call will be in the money.
Other Factors to Consider
Of course, there are many other factors to consider when choosing a strike price, such as the premium (the amount we receive for selling the call), the potential for profit or loss, and our risk tolerance. However, using standard deviation as a guide can be a useful tool in helping us make informed decisions about our covered call trades.
