One of the nice things about options is that they offer the investor a lot of choices (or, if you will, options).? With covered calls, you can change the call you write, depending on your expectations for the stock and your tolerance for risk. Simple rule of thumb, the more worried you are about the downside, the lower your strike price.? The more bullish you are, the higher your strike.? If you believe that the stock will fluctuate in a range around the current stock price, then a covered call that is at-the-money or close-to-the-money is your best option.
By writing this higher strike $45 out-of-the-money call against Micron, you give yourself greater upside potential (13.2% versus 5.9%), but your downside protection is way less (6.1% versus 13.0%).? It is worth noting that the strike price is only 6.3% above the stock price.? It is the rich time premium that gives you the additional profit potential.? The stock would have to rise above $47.59 for you to have been better off by not having written this hedge. This covered call offers a very substantial per annum rate of return, but only if the Micron common ends up above its current $42.43.
The Close-to-the-Money $42 Covered Call offers less downside protection than the $45 call and less upside potential than the $39 call.? However, its per annum yield is way higher than the other choices.? This is because options that are closer to the money have higher time premiums. Thus, we see a 45.6% p.a. yield versus 29.3% for the lower strike call and 32.6% for the higher strike call. ?It is worth noting that the rich time premium offers a decent amount of protection 9.1% and good profit potential also of 9.12%
A Snapshot of the Strategies
The graph below shows the dollar outcomes of the three different covered calls and compares them with just holding the stock.? As you can see, with all three covered call choices there is a fairly broad range in which the investor is better off having hedged with the covered call.
?Prepared by The Value Line Options Strategy Team, vloptions@valueline.com