ITC Covered Call Strategy

Why should you use a covered call strategy?

A covered call strategy can be initiated by simultaneously purchasing a stock and selling a call option. It
can also be used by someone who is holding a stock and wants to earn a regular income. Generally, the
call option which is sold/written will be of at-the-money or out-the-money strike price and it will not get
exercised unless the stock price increases above the strike price.

How should you use the covered call strategy?

Choosing between the ideal strikes involves a trade-off between priorities. An investor can select higher
out-the-money strike price and preserve some more upside potential. However, more out-the-money
would generate less premium income, which means that there would be a smaller downside protection
in case of stock decline. The expiration month reflects the time horizon of his market view.

Delivery Holdings in a stock & Sell call option

Strategy
Long ITC & Short ITC 230 CE
Expiry Date 31st Dec 2020
Market Outlook Moderately bullish
Breakeven(Rs.) at expiry Stock price paid-premium received
Maximum Risk Stock price paid-call premium
Reward Limited
Margin required No – If one can pledge the stock holding

Let’s try to understand the Strategy:

ITC Rs.195
Strike price Rs.230
Premium Received (per share) Rs.1
BEP (strike Price - Premium paid) Rs.194
Lot size (in units) 3200

Let us consider the following scenario: Mr. A has a delivery holding of 3,200 shares of ITC Ltd. Mr A sells
a 15% out of the money call option with a strike price of Rs.230 for Rs.1. The upside profit potential is
limited to the premium received from the call option sold plus the difference between the current market
price of stock at the time of option writing and its strike price.

In the above example, if stock price surges above the 231 level, then the maximum profit would be
calculated as:(195-230 +1)*3200 = (36*3200) = Rs. 115,200. If the stock price stays at or below Rs. 230,
the call option will not get exercised and Mr. A can retain the premium of Rs. 3200 per lot, which is an
extra income. Mr. A can do the similar strategy every month to generate addition income on his stock
ITC Covered Call Strategy

holding. For the ease of understanding, concepts such as commission, dividend, margin, tax and other
transaction charges have not been included in the above example.

What to do if the stock price surge above the Call writing strike price?

As we are selling +2SD OTM strike price, the probability of the stock expiring below the Call writing strike
price is 95%. However, there will be occasions when the Stock could breach the mentioned strike price,
in that case one must follow the following approaches.

1. Give the stock delivery & Sell OTM PE (Do this activity until the stock price reverts back to 230
level)

2. Hold the stock & rollover the call writing positions to the next series

Payoff Schedule:

Note: The covered call strategy is best used when an investor wishes to generate income in addition to
any dividends from shares of stocks he or she owns. However, it may not be a very profitable strategy
for an investor whose main interest is to gain substantial profit and who wants to protect downside risk.

You can also understand the strategy by watching this video here: Click here
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