Leave a Comment / English, Best Dividend Stocks, Best Growth Stocks / By Wyze Investor
Covered calls are a popular strategy to generate passive income while maintaining exposure to stocks in your portfolio. In this article, we explore this method using a practical example with NVIDIA (NVDA). We will also explain how to choose from multiple available options to maximize your gains and reduce risks.
Introduction to Covered Call Options
A covered call involves selling a call option on stocks you already own. By selling the option, you immediately receive a premium, which generates passive income. If the option is exercised, your shares will be sold at the strike price, but you keep the premium.
Why Choose NVIDIA for This Strategy?
NVIDIA is used here as a practical example, but it’s important to note that this strategy can be applied to other companies. However, NVIDIA is an excellent candidate for the following reasons:
High Volatility
Stocks with high implied volatility, such as NVIDIA, offer higher premiums on options. Volatility is a key factor in option pricing: the higher it is, the more lucrative the premium.
However, higher volatility also implies greater risks. Investors must be prepared to manage potential large fluctuations in the stock price.
Leadership in AI and GPUs
NVIDIA is one of the global leaders in artificial intelligence, data centers, and graphics processing units (GPUs). These sectors are in high demand, attracting investors and keeping interest in its stock strong.
NVIDIA’s positioning in a growing sector increases the likelihood of its stock price remaining solid, making the covered call strategy more attractive.
Availability of Options
NVIDIA offers a wide variety of strike prices and expiration dates, giving investors flexibility to meet their objectives. Whether you want to maximize premiums or allow more potential appreciation for the stock, NVIDIA provides suitable options.
Can You Choose Other Companies?
Absolutely! NVIDIA is just one example. The covered call strategy can be applied to any publicly traded company, as long as you choose your stocks wisely. Below are some general criteria to help you select stocks for this strategy:
Option Liquidity
Prioritize companies whose options are highly liquid. High liquidity ensures active trading, making it easier to sell options at competitive prices.
Example: Companies like Apple (AAPL), Microsoft (MSFT), or Tesla (TSLA) have very active options markets.
Volatility According to Risk Tolerance
- High Volatility: For higher premiums, consider more volatile stocks like NVIDIA or Tesla. Keep in mind, however, that higher volatility also increases the risk of loss.
- Moderate Volatility: If you prefer a more conservative approach, stable stocks like Procter & Gamble (PG) or Johnson & Johnson (JNJ) are better choices. These companies provide smaller premiums but tend to have lower price fluctuations.
Stocks You’re Willing to Hold
Select companies you trust and are comfortable holding even if the market becomes volatile. Dividend-paying blue-chip stocks are often a good option.
Alignment with Your Investment Strategy
If you’re a long-term investor, choose stocks in sectors you understand and where you see sustainable growth potential.
Example of Selection Based on Risk Profile
| Risk Tolerance | Examples of Companies | Why? |
|---|---|---|
| Conservative | Johnson & Johnson (JNJ), Procter & Gamble (PG) | Stable companies, low fluctuations, modest premiums. |
| Moderate | Apple (AAPL), Microsoft (MSFT), Coca-Cola (KO) | Strong growth with moderate volatility. |
| Aggressive | NVIDIA (NVDA), Tesla (TSLA), Palantir (PLTR) | High premiums but more volatile and riskier stocks. |
Steps to Sell a Covered Call
Select the Stock
You must own at least 100 shares for every option contract you sell. Choose a stable or growing stock that you’re willing to hold long-term.
Choose the Strike Price
The strike price should align with your strategy:
An Out of The Money (OTM) strike (above the current price) maximizes potential gains while generating attractive premiums.
Choose the Expiration Date
Short-term expirations (30-60 days) are often the most effective for generating regular premiums.
Practical Example: Analysis of the NVIDIA $149 Strike Option
Below is an example based on NVIDIA options (data as of January 3, 2025).
| Parameter | NVIDIA $149 Strike Option |
|---|---|
| Current NVDA Price | $141.91 |
| Premium Offered | $2.76 per share |
| Expiration | January 3, 2025 |
| Implied Volatility | 34.34% |
| Delta | 0.3478 |
| Total Income (1 Contract) | $276 |
Scenarios
- Stock Stays Below $149: You keep your shares and the premium ($276).
- Stock Exceeds $149: Your shares are sold at the strike price, but you keep the premium and gain up to $149.
- Stock Drops Significantly: The premium received reduces your overall loss.
Choosing the Right Options: Criteria and Flexibility
The option presented ($149 strike) is just one example among many. Depending on your financial goals and risk tolerance, you can choose other options from those available. Below are factors to consider:
Comparing Available Options
| Strike | Premium (per share) | Potential Gain on Stock | Delta | Implied Volatility |
|---|---|---|---|---|
| $145 | $4.40 | Moderate | 0.44 | 33% |
| $149 | $2.76 | High | 0.34 | 34% |
| $150 | $2.58 | Very High | 0.30 | 35% |
Strategy Based on Objectives
- Conservative Investor: Choose a strike close to the current price to maximize premiums (e.g., $145).
- Optimistic Investor: Opt for a higher strike (e.g., $150) to capture additional gains if the stock rises.
Short-Term vs Long-Term Expirations
- Short-Term (e.g., 27 days): Offers regular premiums and more flexibility.
- Long-Term: Requires less active management but may result in slightly lower premiums.
Advantages and Risks of the Strategy
Advantages
| Advantage | Explanation |
|---|---|
| Immediate Income | Premiums are received as soon as the options are sold. |
| Flexibility | Choose from a variety of strikes and expirations. |
| Cost Reduction | The premium reduces your average purchase cost for the stock. |
Risks
| Risk | Explanation |
|---|---|
| Capped Gains | If the stock exceeds the strike, your gains are limited. |
| Significant Drop | A sharp decline in the stock price can result in a capital loss. |
| Early Assignment | The option may be exercised before expiration if the stock significantly exceeds the strike price. |
Conclusion
Covered calls provide a unique opportunity to generate passive income while holding onto your stocks. Using the NVIDIA $149 strike option as an example, we’ve demonstrated how this strategy works. However, every investor can adapt this method based on available strikes and expirations.
Before starting, analyze key option parameters (premium, volatility, delta) and adjust your strategy according to your objectives. With prudent management, this method can transform your portfolio into an efficient income generator.
With this information, you’re ready to explore covered calls and optimize your investments for sustainable passive income.