How to trade Options for beginners: Covered Call via moomoo app

How to trade Options for beginners: Covered Call via moomoo app

In this article, I will be sharing a very simple approach to making some extra cash using covered calls. This approach is particularly useful if you’re already holding onto minimally a hundred shares of a particular stock.

Now before we begin, it’s important to know what covered calls are.

This post was originally posted here. The writer, Everest Fortune Group, is an Award-Winning Research House and Singapore FinTech Company.

Covered Call:

  • You are holding a long position in a stock (usually at least a 100 shares since 1 call option is equivalent to 100 shares)
  • You sell (write) a call option on that same stock
  • Useful when you don’t expect prices to go beyond a certain level in the next X days.

Notice that for a covered call, you are already holding onto shares of a particular stock and are looking to increase your profits from it.

How would you use a covered call?

In trading, there is usually support (below price) and resistance (above price). Usually, prices tend to drop when they hit a resistance level.

Now, covered calls are very useful when you don’t expect prices to go beyond a certain resistance level within the next X days.

For example, let’s take a look at this chart example on Taiwan Semiconductor Manufacturing (TSM). We can see that price is current at 124.28 has repeatedly tested the 127 resistance area and failed to break through there.

For illustration purposes only

Let’s assume you are already holding onto 100 shares of TSM which you bought at $100 and you’re sitting there thinking – “Alright, I’m bullish on TSM long term, but how do I make some money out of this in the short term as it seems to be unable to break beyond 127..?”

What you can do in this scenario is to sell (write) a call option with a strike price of 127. When you sell a call, you will immediately receive a premium – meaning that people would pay you to buy that call from you, essentially putting money in your pocket (or in this case, your moomoo wallet).

Now, if you have 100 shares of TSM, then the maximum number of call options you should sell is ideally 1 – because 1 call option is equivalent to 100 shares. Selling more than these would be very dangerous because if price really does break the 127 area and rise strongly, you could be suffering huge losses.

Picking the right expiry dates

Okay, so back to us selling 1 call option on TSM with a strike price of 127. The next very important question you have to ask yourself is – how long do you think it will take before it breaks the 127 level?

For illustration purposes only

As we can see from the picture above, historically, price has failed to break this level for over 259 days dating all the way back to March 2021. So with a degree of confidence, you can estimate that it should not be breaking this level in the next 30 days (so roughly, 23rd December 2021).

So our hypothesis now consist of the following:

  1. Price is unlikely to break beyond the 127 level because it has repeatedly reversed from that strong resistance.
  2. This scenario is relevant for at least the next 30 days.

With this hypothesis in mind, we will now head over to the moomoo platform and look up TSM’s option chain and see how we can make some money selling a covered call position.

On the moomoo trading platform

After searching for and selecting TSM, you’ll want to filter out the option chain to only show “Call” options for now (so it’s less confusing). This will turn the option table from this:

For illustration purposes only

Into this:

For illustration purposes only

Next, you’ll select the expiration date to be the closest to your estimate (in this case, 23/12/2021)

For illustration purposes only

Once done, you can zoom in on the strike price (127) and see how much you can earn by selling that call option (bid price).

For illustration purposes only

We can see that selling one call option would give you $2.99 x 100 units = $299 right away.

Now, there are 2 scenarios that will play out and I’ll share with you how each will affect your trading profits.

1st Scenario: Price of TSM remains below 127 by 23rd December 2021

  • In this scenario, you will get to keep the full $299 you made from selling the call option since the buyer won’t exercise it.

2nd Scenario: Price of TSM goes beyond 127 (eg. 135) by 23rd December 2021

  • In this scenario, you won’t be able to benefit from any price increase beyond 127 for TSM since the buyer of the call option would exercise it at its strike price of 127 – essentially buying the 100 shares of TSM you own for that price.
  • You would have made $299 + the price increase from 100 shares * (127 – 124.28) = $272 which would be $571.
  • However, you could have made 100 shares * (135 – 124.28) = $1,072

As you can see in this above example – there are pros and cons of selling a covered call. On the one hand, if price doesn’t go beyond your strike price (which you identified as the strong resistance), then you would have bagged a decent amount of money from the premium of selling it.

On the other hand, if it really does go beyond your strike price, you won’t be able to benefit from the money you otherwise could have made.

How do we improve the probability of profitability?

Now that you know how a covered call option works, the key question we have to ask ourselves is: what are some methods you can use to increase your probability of being profitable when trading the covered call option strategy?

One of the easiest ways to do this is through technical analysis – with the most commonly used approach of identifying strong support and resistance areas. In this case (covered calls), you will be looking for resistance areas (i.e. above price).

To do this, you ideally want to look for levels which price has reversed off multiple times significantly in the past. For example, this was what the chart looked like of TSM on the moomoo platform:

For illustration purposes only

Scanning through some popular stocks, we can see that Amazon (AMZN) also has a huge reversal off the 3700 area.

For illustration purposes only

The more times price reverses off a certain horizontal level, the stronger that level is. Using this knowledge, you can apply this to your current portfolio of shares and see whether any of them are approaching such key resistance levels.

It’s important to take note that you should never be overconfident on your trade no matter how nice the set up looks. It’s equally important to apply proper risk management when it comes to trading – as there is still a chance that price might break the resistance level.

How close should price be to these key resistance levels?

So one big factor that goes into the premium you get when selling a call option is how close current price is to it. If you think about it – the further current price is from the strike price, the less likely it will get there and hence, the less it would be worth.

To get an idea of this, let’s look at the TSM example we were discussing previously. Remember, our current price was at 124.

For illustration purposes only

As you can see in the picture above, selling a call with a strike price of 127 would have got you $2.99 * 100 = $299

However, selling a call with a strike price of 135 would have only got you $1.29 * 100 = $129

The further the call option’s strike price is from your current price, the less money you would get for selling that call option.

So with this theory in mind, we would ideally be looking for price to be really close to these key resistance levels before we use this covered call options strategy.

What forms of technical analysis are there?

I may not be the best at fundamental analysis, but when it comes to technical analysis, I’m kind of like this guy:

My firm are finalists for the hugely competitive and prestigious “Technical Analyst Awards” for Best FX Research (2019, 2020, 2021) and Best Equity Research (2021) and our charts often look like Picasso had one too many drinks. Even though I can’t cover everything here, I would like to highlight a few approaches which we found are more reliable:

  • Support & Resistance
  • Ichimoku
  • Fibonacci (retracements, extensions, expansions)
  • Fibonacci (projections)
  • Correlation
  • Natural moving averages
  • Valid trend lines & Channels

These are a few which you can dive into to get a better understanding on – applying them when you trade covered calls can potentially give you a strong edge over the market.

What is the opposite of a covered call?

What if you are short on a market and looking to make some extra money off those positions like a covered call?

The opposite of a covered call is a covered put. It is a bearish strategy and essentially involves you selling at least a hundred shares and then selling (writing) put options at strike prices which you don’t think the stock would go down too.

Final thoughts

The amazing thing about covered calls is that you can find many opportunities to make an additional profit, especially when the markets are going sideways.

Traditionally, some months tend to be slower (eg. December) and knowing how to leverage on such strategies could improve the overall profitability of your portfolio.

This month via moomoo trading platform they have launched a $0 commission* Options trading. Click here to find out how you can collect all 6 options-related cards to get double the rewards! This promotion ends on 31 Dec 2021.​

The moomoo trading platform provides a really comprehensive and easy to use options pricing table which you can easily see not only the bid/ask prices, but other very important option greeks that if you combined with the support/resistance strategy I’ve shared, could help you trade even better.

All images in this article are for illustration only.

This article was written by Everest Fortune Group in collaboration with FUTU SG.

Disclaimer: This written article should be taken as of a general nature and should not be taken to constitute as financial or trading advice, guidance or recommendations with regards to any trades, investments or decisions in any matter. It is your duty to approach a professional advisor If you are relying on any part of this article. Any investment or trade is solely at your own risk and you will not hold Everest Fortune Group Pte Ltd, FUTU SG or Investing Note Pte Ltd liable whatsoever for any losses you might incur.

Once again, this article is a guest post and was originally posted on Everest Fortune Group‘s profile on InvestingNote. 

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