While the title might be enticing, especially for those with smaller accounts, achieving a 10X return on covered calls is aggressive and requires a strategy beyond simply selling covered calls. Let’s delve into covered calls, understand their limitations for maximizing returns, and explore alternative strategies that might be better suited for small accounts.
A covered call involves owning 100 shares of a stock (the “covered” part) and simultaneously selling a call option contract on those shares. The call option grants the buyer the right, but not the obligation, to purchase your shares at a specific price (strike price) by a certain time (expiration date). You collect a premium for selling this call option.
There are two main scenarios:
- Stock price stays below strike price at expiry: You keep the premium as income and retain ownership of the shares.
- Stock price rises above strike price at expiry: Your shares are called away (sold) at the strike price, and you pocket the premium along with any profit from the rising stock price (up to the strike price).
The key advantage of covered calls is generating income (premium) regardless of the stock price direction. However, there’s a capped profit potential if the stock price surges significantly.
Limitations of Covered Calls for Maximizing Returns
- Capped Profits: If the stock price explodes past the strike price, you miss out on those potential gains.
- Lower Overall Returns: Compared to directly owning the stock and enjoying unlimited upside potential, covered calls limit your returns by the premium amount.
Alternatives for Small Accounts
Since maximizing returns is the goal, here are some alternative strategies that might be more suitable for small accounts:
- Cash-Secured Puts: Similar to covered calls, but you sell a put option instead. You collect a premium and agree to buy the stock at a specific price if assigned (exercised) by the option buyer. This strategy benefits from a declining stock price but limits upside potential.
- Debit Spreads: Involves buying a call option with a lower strike price and simultaneously selling a call option with a higher strike price on the same stock. This strategy caps your potential profit but also limits your risk compared to buying a single call option outright.
Important Considerations for Small Accounts
- Focus on Risk Management: Small accounts have less capacity to absorb losses. Employ strategies with defined risk like debit spreads or cash-secured puts.
- Start Small: Regardless of the strategy, begin with a small number of contracts to understand the mechanics and manage risk effectively.
- Do Your Research: Thoroughly research the underlying stock, option greeks, and market conditions before deploying any options strategy.
Remember: Options trading involves a significant degree of risk. These are complex strategies, and it’s crucial to understand the risks involved before using them, especially with a small account. Consider paper trading (simulated trading) to practice these strategies before risking real capital.