It is an accepted fact that covered call is a great way of creating wealth through stock markets and without much involvement, i.e quite passively. If we want to capture a good amount of capital appreciation of stock markets, covered call can help to capture that with minimum risk.
But again, different markets have different products. If we go by Indian stock markets, covered call in stocks may not be a great strategy because of very low or no liquidity in stock options , at least for second month onwards. So, only choice left with us for covered call is Nifty. And because of the type of options available in Nifty, any amount of capital appreciation can be captured with practically nil risk if we add the extra leg (which is the topic of this blog).
Traditional, copybook style covered call has two issues :-
a. Upside growth is very limited – You cannot capture profits beyond the strike price of sold call and hence in case of any break out in the stock which is quite big , investor of covered call is hardly able to capture small part of it. This need to be worked out and handled properly if you really want to capture huge growth . With huge growth, I mean to say something like 100% to 900% over a period of time. Nifty was around 1000 in 2001 and touched 9000 in 2015. So, 9 times in fifteen years.
What will happen in fifteen years from now ? If we again take it as 9 times (although market experts think it will be much more), it makes it to something in the range of 80000 , eighty thousand.(yes, Nifty, not sensex).
So , if we are talking about this kind of growth, we must lay down a proper process to capture this growth , which is impossible with traditional covered call. You need to learn the smart covered call technique.
b. Downside risk is very high – As in covered call, one has purchased stock in cash, the downside risk is wide open as stock can even become a penny stock. Sold call will not protect beyond a point. This is where, creating covered call in Nifty makes much more sense as there is very little chance of Index become zero or something like penny Index.
Now, here comes the use of this extra leg. As on closing of 14th October, 2016 , if I see Nifty December 2017 , options , 8000 put is available in Rs 226 /-. If I add this extra leg to my covered call, I am fully protected for any downside below 8000. And I have 14 months in which we will be making decent money from selling calls.
If we calculate a protection fee of Rs 226 for 14 months , it comes out to be less than Rs 17/- per month. This is the insurance premium I have given for the money I have invested. Its hardly anything. It totally takes care of any big downside risk and in fact , if I manage my calls well , this additional leg can help me very effectively in capturing profits even in falling markets.
And as we know, any strategy will not work automatically. Even best of the strategies need effective management. Even best of the cars, do not run automatically. They need good drivers.(Even auto or self driven cars have limited capacities). It always make sense to learn the pros & cons of strategy and its management, before committing any serious money into it.
But yes, it is also important that you do not miss the bus and remain loyal to bank deposits , which are eroding your money, pretty fast. Some action is required to begin the process !