The Deep In-The-Money Covered Call

The next option strategy I’m trying is a deep-in-the-money, covered call.

Yes, I know that this blog is essentially about dividends. But I’m in my playing-with-options phase.

What if you can invest in a strategy almost guaranteed to make money? Does such a thing exist?

Let’s look at an example of such a strategy: a deep-ITM covered call:

For example, the 70 CALL of BABA for Nov 17, 2023 has a delta of 0.9483.

What is the greek term DELTA: That means the call option is expected to move $0.95 for every $1 up or down the $BABA (Alibaba) stock moves. Put another way, the options market expects the call option to expire in-the-money 95% of the time. Only 5% of the time will $BABA stock be lower than $70 on Nov 17, 2023.

Deep ITM calls provide price drop protection. The current price of $BABA is $86.72. So, for it to fall to $70 in the next 53 days would be a 19% drop.

So a covered call on $BABA would look like this:

Purchase 100 shares of $BABA for $86.72 per share
Sell 1 CALL option of $BABA Nov 17 for $17.75 per share
Net cost: $68.97 per share. Assuming the stock will be called away at $70, that means a profit of $1.03.
95% of the time, the stock will be “called away”, and the max profit scenario will be hit
$1.03 profit for a $68.97 investment means a 1.47% rate of return for 52 days.

My plan is to roll this option with 15 days to go in the trade (before 35 days from today) to capture most of this $1.03. So, I can collect $0.50 of that $1.03 in the next 30 days. And sell another call option for another 45 days out and collect another $1.03.

If I can make this trade every month and sell a 0.95 delta call on these shares without the shares dropping below the strike price, I can net 18% after 12 months.

What happens if the stock falls?

I have lots of downside protection—19% protection at the moment. Every month, I sell a new call on the same shares, and I increase my downside protection.

It also helps that I don’t mind owning the shares. So if the price does fall, and I end up holding BABA with a loss, I will hold it.

What happens if the stock goes up?

Due to the fees, I don’t want the option to be exercised. I will hold on to it. Once the $1 profit is made from the option, I can roll it up to a new strike in the same month for more credit. Or roll it out to the next month. I do not make money from the stock going up or down (up to the strike price), but I can collect more credit by rolling the option to a higher strike.