What are the characteristics of this option strategy?
In the money covered calls sell a call whose strike sits below the current share price against a long position in the underlying, either 100 shares per contract or a deep in the money LEAPS call used as a stock substitute. Because the strike is already in the money, most of the premium collected is intrinsic value, so the position starts with a larger cushion than an out of the money covered call. That cushion is paid for: every cent of gain above the short strike belongs to the buyer of the call from the moment the trade is opened, and the cushion itself is only as large as the premium received.
Is this a bullish, bearish or neutral strategy?
The in the money covered call option strategy is a bullish to neutral position. The in the money long call carries a delta close to 1.0, so the position is net long the stock. The premium received cushions a modest decline but does not neutralise direction, and it does not offset a large drawdown.
Is this a beginner or an advanced option strategy?
This strategy requires a moderate level of knowledge and understanding of options trading, so it is considered an advanced strategy.
In what situation will I use this strategy?
This strategy works best when the underlying stock is performing in a range-bound pattern and is expected to remain relatively directionless.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The reward is capped and known from the outset: the most this position can make is what the long leg is worth at the short strike, plus the premium collected, less what was paid for the long leg. The downside is not symmetrical. The premium received offsets only a small part of a decline, and the position still carries the full loss on the long leg below that. If the shares go to zero, or if the long LEAPS call expires worthless, the loss is the entire amount paid for the long leg less the premium collected. The probability of profit depends on the time to expiration and how far in the money the short strike sits.
How is this strategy affected by the greeks?
The greeks (delta, theta and Vega) will affect the in the money covered call option strategy as with any other options strategy. Delta will affect the amount of levers the strategy will be able to utilize and Theta will affect the rate of decay in the option and Vega will affect the rate of decay as volatility changes.
In what volatility regime (i.e VIX level) would this strategy be optimal?
The in the money covered call option strategy is typically most optimal when the VIX level is between 15-25.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
Adjusting this strategy when the trade goes against you will involve closing out the option position at a loss and then re-initiating the strategy with a higher strike price. Depending on the market conditions at the time, this could involve a series of adjustments with the goal of eventually getting back to the original position. This strategy is relatively easy to adjust as it just involves taking the opposite end of the previous position.
Where does this strategy typically fall in the range of commissions and fees?
The commissions and fees associated with the in the money covered call option strategy will vary depending on the broker, but most brokers offer reasonably competitive fees.
Is this a good option income strategy?
The in the money covered call option strategy can be a good option income strategy when utilized with the right underlying stock. It provides income and a cushion against a decline, but the cushion is only the size of the premium collected and does not protect against a large drawdown. Gains above the short strike are given up, so the income comes at the cost of the upside.
How do I know when to exit this strategy?
The in the money covered call strategy can be exited when the underlying stock has moved sufficiently to offer the opportunity for profits, or when the underlying stock has moved sufficiently away from the strike price of the option such that the net investment is losing money.
How will market makers respond to this trade being opened?
Market makers will typically respond favorably to the in the money covered call option strategy as it provides liquidity and offsetting of orders which helps to provide an orderly market.
What is an example (with calculations) of this strategy?
For example, assume an investor purchased 10 GE LEAPS calls at a $15 strike expiring in January of the following year, at a cost of $2,500. The long call must sit at a lower strike and a later expiration than the call that will be sold against it, otherwise the two legs cancel out and there is no position at all. The investor then sold 10 GE calls at a strike price of $20 with June expiration for $550. The LEAPS cost $2,500 and the investor received $550 in income from the option sale, for a net cost of $1,950. Gains on the long $15 calls accrue up to the $20 short strike and no further while that call is open. If GE is above $20 when the June call expires and the whole position is closed there, the $15/$20 structure is worth at most $5.00 per share, or $5,000 on 10 contracts, against the $1,950 net debit, so the most that can be made is roughly $3,050 before commissions. The break even on the long leg is $16.95, the $15 strike plus the $1.95 per share net debit. The loss is capped but it is not small: if GE sits below $15 when the LEAPS expire, the entire $1,950 net debit is lost, and the $0.55 per share collected on the short call covers only a fraction of that.
MarketXLS
MarketXLS is a powerful Excel toolkit that can help you analyze your options trades with calculation and analysis tools. You can use MarketXLS to manage your stock portfolio, analyze options trades, and even help you construct collar option strategies, all within Excel. With MarketXLS you’ll have access to advanced calculations, analytics, and customized data delivered directly to your spreadsheet. MarketXLS can also help you quickly and easily place trades with just one click by connecting to major brokers. With MarketXLS, you’ll have the analytics and productivity tools to help you make profitable options trades with confidence.
Here are some templates that you can use to create your own models
Covered Call Option Strategy
Covered Put
Covered Put
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic
Covered Calls – What They Are & How You Can Profit (With Marketxls Data)
The Wheel Strategy For Options (Explained With Example)
Options Trading (Strategies)
Options Investing: The Best Way to Profit from Volatility
Collar Option Strategy – A Synopsis