My Covered Call Strategy - Comprehensive Guide / Tutorial For Writing Covered Calls

smartcat

Active Member
#1
Everybody,

I would like to pen down my covered call writing strategy. As many would agree, this is one of the safest option strategies to implement - if you know what you are doing. I expect a return of around 15% per annum via premium income and 15% CAGR per annum via capital appreciation - net net a return of 30% CAGR over a long term. Yes - 30% CAGR is achievable via "buy and hold" strategy on fundamentally strong midcap stocks too. But my covered call strategy gives me the same returns with lower volatility and *almost* guaranteed monthly income.

Minimum investment required for this strategy is around Rs. 5 Lacs. Ideally, ANOTHER Rs. 5 Lacs should be invested in fundamentally strong stocks (I'll explain this part later).

This tutorial will have multiple sections -

Part I - How to pick the right stocks for the strategy

You select the wrong stock for the strategy and your returns go down the drain. So I'll be spending more time explaining how I select stocks for writing covered calls.


Part II - Which strike price to write call

We will only be writing far out of money calls - irrespective of the outlook on the stock or the market conditions. The idea is to increase the chances of keeping the premium, and not disturb the stock holdings as far as possible.

Part III - What to do with stock price falls or goes up drastically within a month.

Basically, we will be rolling up the calls when the stock price goes up and rolling down the calls when the stock price goes down.
 

smartcat

Active Member
#3
Re: My Covered Call Strategy - Comprehensive Guide / Tutorial For Writing Covered Cal

Part I - HOW TO CHOOSE THE RIGHT STOCK FOR WRITING COVERED CALLS

1) Elephants do not dance. Giant market cap companies generally are not volatile. So we take a look at the list of Nifty companies with the largest market cap first.

http://www.equitymaster.com/india-markets/nse-replica.asp?order=mktcap%20desc

Companies like Kotak Bank, ACC Ltd, IDFC etc might be fundamentally OK - but we avoid writing calls against such companies because the market cap is too low. Stocks of such companies generally have very high volatility - which is the main enemy of covered call strategy. We only look at the top 10 or 20 market cap companies like RIL, ONGC, ITC, INFY etc.

Exceptions can be made for certain pharma companies, whose market cap might be low, but they have very low volatility too.

2) The next step is to choose companies which are seeing steady year on year increase in both sales and profits. Eg: ITC

http://www.edelweiss.in/market/Financials.aspx?co_code=301&tb=BalanceSheet

Every year, ITC has increased both sales and profits. Generally, FMCG and pharma companies fit the bill. But not all companies - one has to check the balance sheet of the company.

Example of a WRONG stock for writing covered call - RANBAXY. You can check the results for the last 4 years here.

http://www.edelweiss.in/market/Financials.aspx?co_code=469&tb=BalanceSheet

Although sales are increasing every year, the net profits are extremely unpredictable. Such companies are a NO NO!

Companies that we choose for writing covered calls should ideally have low debt and high RoE too.

3) Now check the all time price graph of the stock on Moneycontrol.com. Let's take a look at ITC first.

View attachment 17813

ITC is almost a perfect candidate for writing covered calls.

- The long term trend is UP (because the company is fundamentally strong)
- Stock market crashes don't bother ITC's investors (actually, ITC goes up in bearish times)
- Even if the stock goes down, it goes down SLOWLY.


Now let's look at another fundamentally strong company - State Bank of India. But looking at its chart, one can easily make out that it is a WRONG candidate for writing covered calls.

View attachment 17814


The stock goes all over the place because it has high beta. When Nifty goes up, SBI shoots up. But when Nifty goes down, SBI falls down like a brick. Such stocks are never ideal candidates for writing covered calls - because you will be hit on both the ends - when the stock is going up and when the stock is going down.
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To Be Continued:
 
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smartcat

Active Member
#4
Re: My Covered Call Strategy - Comprehensive Guide / Tutorial For Writing Covered Cal

good initiative. If only exchanges would identify such strategies and give margin benefit !

still a good strategy.

all the best
Whether exchanges give us margin benefit or not, it shouldn't bother us. We need to first fix the kind of returns we want, and then go ahead and write calls.

For eg:

- Let's say I'm shooting for 20% annual returns from premium income for each stock.
- I buy 250 shares of Reliance Industries @ Rs. 750 for an investment of Rs. 1.87 Lacs.
- I keep a margin of Rs. 27,000 as mandated by the exchanges.
- My total investment is Rs. 187000 + Rs. 27000 = Rs. 2.14 Lacs.
- I shoot for 20% returns as premium income. That is, an income for (20% x Rs. 2.14L) = Rs.42,800 every year.
- That means, I need to earn a premium income of approx (Rs. 42,800 divided by 12) = Rs. 3,500 per month.

Basically, fix the amount of returns you are expecting on your investment (stocks + margin) - and write out of money calls so that you get that returns in a year.
 

psvaja

Active Member
#5
Re: My Covered Call Strategy - Comprehensive Guide / Tutorial For Writing Covered Cal

Very good initiative.. looking since a long time. thanks
 

smartcat

Active Member
#6
Re: My Covered Call Strategy - Comprehensive Guide / Tutorial For Writing Covered Cal

HOW TO CHOOSE THE RIGHT STOCK (CONTINUED):

The next step is to check if the stock option has enough liquidity. Since we write OTM or far OTM calls, ideally, the call option of the stock should have enough volumes at 4 to 5 strike prices.

That's why HERO MOTOCORP makes a very good candidate for writing covered calls - good fundamentals, excellent graph (low volatility) and good volumes.


picture hosting

While SUN PHARMA too fits the bill (good fundamentals, low volatility), calls options don't have enough volumes for our strategy - and hence not a suitable candidate for writing covered calls.


adult upload image


A few more tips for selecting stocks for writing covered calls:

- Avoid commodity stocks like mining, steel, copper, aluminium, cement etc.
- Refining/oil & gas sector stocks are OK. But oil marketing companies (Eg: BPCL) are not.
- Avoid newly listed companies like Coal India, Cairn India etc because we don't know how volatile they will be over a long period of time.
- If a company has seen more than 25% fall in profits in any year in the past 4 years, avoid such companies.
- Avoid traders favorite stocks like Suzlon, Anil Ambani stocks, JP Associates etc.


My List Of Stocks For Writing Covered Calls (Among Nifty Stocks) -

RIL
ONGC
TCS
ITC
NTPC
INFOSYS
HDFC BANK
HDFC
HUL
CIPLA
POWER GRID LTD
HERO MOTOCORP
M&M
PNB


Coming up next - How To Select The Right Strike Price For Writing Calls.. I'll update this section after the expiry of April options - it would make more sense to explain how I select strike prices in May (since we are already half way through April).


For some reason, I'm unable to upload more images - so I'm using external image hosting site for uploading pics.
 
Last edited:

comm4300

Well-Known Member
#7
Re: My Covered Call Strategy - Comprehensive Guide / Tutorial For Writing Covered Cal

the stock option chain looks different from the one found in nse website.

is this from any other site?

can you share the source?

thanks,
 

mmca2006

Active Member
#10
Re: My Covered Call Strategy - Comprehensive Guide / Tutorial For Writing Covered Cal

Everybody,

I would like to pen down my covered call writing strategy. As many would agree, this is one of the safest option strategies to implement - if you know what you are doing. I expect a return of around 15% per annum via premium income and 15% CAGR per annum via capital appreciation - net net a return of 30% CAGR over a long term. Yes - 30% CAGR is achievable via "buy and hold" strategy on fundamentally strong midcap stocks too. But my covered call strategy gives me the same returns with lower volatility and *almost* guaranteed monthly income.

Minimum investment required for this strategy is around Rs. 5 Lacs. Ideally, ANOTHER Rs. 5 Lacs should be invested in fundamentally strong stocks (I'll explain this part later).

This tutorial will have multiple sections -

Part I - How to pick the right stocks for the strategy

You select the wrong stock for the strategy and your returns go down the drain. So I'll be spending more time explaining how I select stocks for writing covered calls.


Part II - Which strike price to write call

We will only be writing far out of money calls - irrespective of the outlook on the stock or the market conditions. The idea is to increase the chances of keeping the premium, and not disturb the stock holdings as far as possible.

Part III - What to do with stock price falls or goes up drastically within a month.

Basically, we will be rolling up the calls when the stock price goes up and rolling down the calls when the stock price goes down.
Smart cat
Thanks lot for such valuable thread , want to know the procedure when price goes upwards , how to save myself in that situation, what is the correct strike price to be shorted etc. , waiting for your next move.:)
 

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