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Covered Calls Investing: OTM (out-of-the-money) Covered Calls

Updated on January 23, 2009

Covered Calls: OTM (out-of-the-money)

An OTM (out-of-the-money) Covered Call (CC) is a CC position where the call option strike price is ABOVE the price of the stock.

For example:

  • Stock at: $48
  • Call option strike (OTM) at: 50

An OTM CC is usually written (sold) when the investor thinks that the stock has room to move up. This allows the CC writer (investor) to not only capture the premium from selling the Covered Call, but also allows the investor to profit from upside gains of the stock.

By selling an OTM CC, the investor is willing to have the stock sold at the call option strike price.

So, from our example above, if the investor purchases the stock for $48/share, and they write (sell) a CC position at a strike price of 50, the CC investor is willing to let the stock be called away (purchased) at $50 (the call option strike price).

In addition (and this is one great aspect of Covered Calls investing), the CC investor will get paid a premium upfront for taking upon themselves this obligation (to deliver the stock at the strike price of $50).

 

Pros and Cons of the OTM Covered Call

 

PRO's:

  • The OTM CC position can participate and gain from upward stock movement

CON's:

  • Less premium is received upfront (compared to an ITM/in-the-money Covered Call)
  • Because less premium is received upfront, there is less downside protection (if the stock moves downward)

 

When to use an OTM CC (instead of an ITM CC)

 

Basically, if you feel the stock has some room to move to the upside, then the OTM CC would be preferred over the more conservative ITM (in-the-money) Covered Call.

To compare the OTM CC versus the ITM CC, see our Hub on:

ITM (in-the-money) Covered Calls

 

OTM CC - Example

Thank you, and Contact Information

Thank you for taking the time to visit our Hub on Covered Calls Investing.

Best Regards,

-----
Shane Johns, President
http://www.CoveredCalls.com
Email: Writer@CoveredCalls.com

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    • profile image

      techx 

      9 years ago

      "Because less premium is received upfront, there is less downside protection (if the stock moves downward)"

      I do not quite follow here. Options with strikes nearest to the spot usually have the highest extrensic value.

      While an ITM call may have a high value most of this is from the intrinsic value. If the stock price decreases losing the investor is losing either extrinsic value (in the case of the ITM CC) or stock value (in the case of ATM/OTM CCs). Either way downside protection is limited to what the investor received from the option's intrinsic value, isn't it?

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