With a covered call and protective put strategy, you have a win – win- win –win situation. Here is what happens when the underlying stock changes:
- Stock price increases – you win by keeping the premium and either rolling up your call to a higher strike price or letting the stock get assigned;
- Stock price is unchanged – you win by keeping the premium and possibly the stock to write more calls against it in coming expiration months;
- Stock price slightly declines – Your amount of premium received will cover a slight decrease in the stock price so you win and keep the stock for more call writes for income;
- Stock price declines aggressively – the protective put will gain value as stock prices decline closer or through the put strike price while you keep the premium and stock for more writes.
If you use the covered call with a protective put, you can create a great wining trade. This is better for writing calls against a stock several months as this will offset the cost of buying a put for protection. The protective put should be at least six months ahead of the current call expiration month when initially purchased. This allows the investor to spread the put cost over the six month period to increase the profitability of the trade. For example, if the protective put cost $300 to buy, the cost will average $50 per month on average. However, if you exit the covered call position before the put expires, you can sell the put to recoup some of its cost.
In the case of a significant price decline, the put will become more profitable as it will increase in value. The call writer can buy back the sold call
for pennies and sell a new call at a lower strike price to get more premium income. After a few months of this, the trade should be profitable.
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