Covered Call Trade Order

It all starts with the trade order. We have examined bid and asked price quotations and various order types. Now we will see how to properly open and close a covered call position.

Opening a Covered Call Position

Stock Trade Commands

Stock is simply bought or sold in a covered call trade order. It is bought upon trade entry (often abbreviated as “BOT”) and sold upon closing of the position.

Option Trade Commands

Stock options are never just bought or sold, but are instead bought or sold in order to open or close. The following table lists the option trade commands and how they are used:

Figure 4.10

Option Trade Commands
Abbreviation Command When Used
STO Sell to open Used to short options; we STO calls to write a covered call.
BTC Buy to close Closes short option position by repurchasing the options. Necessary to close a covered call.
BTO Buy to open Opens a long option position.
STC Sell to close Closes a long option position by selling the options.

For example, opening a bear call spread, in which we sell a call and buy a higher-strike call, would involve two orders to open. Let’s assume we sold the DELL Dec. 22.5 Call and bought the DELL Dec. 25 Call; we would sell the 22.5 Call to open and buy the 25 Call to open. We would close the trade with buy and sell orders to close:

Figure 4.11

Option Trade Commands – Bear Call Spread
Opening Orders Options Closing Orders
Sell to Open (STO) DELL Dec. 22.5 Call Sell to Close (STC)
Buy to Open (BTO) DELL Dec. 25 Call Buy to Close (BTC)

The Trade Order Form

Every trade order submitted online requires you to fill out a trade order form, no matter the type of trade being placed. These are the elements of every covered call trade order:

  • Stock symbol
  • Stock action taken (buy or sell shares)
  • Number of shares being bought (or being sold, when closing)
  • Call option symbol
  • Call option action taken (sell to open, buy to close)
  • Number of call contracts being sold to open (or bought to close)
  • Price
  • Duration of order (Day and GTC frequently are the only choices)
  • Advanced orders, if any (contingent, etc.)
  • Routing of order (where a choice is provided)

The trade order is where the covered call comes to life. The covered call trade order form is simplicity itself, and entering the order is a simple process. Before running a trade, you should be clear on several important elements of the trade.

Decisional Process for Trade Order

  1. Position Size. The first decision is the size of the position – how many shares and contracts. In a covered call position, the number of shares bought/owned and contracts written must balance. If you are writing less than all your portfolio shares, the order nonetheless must balance.
  2. Entry Strategy. You must decide whether to write the calls simultaneously with the stock buy (that is, enter it as a combo trade) or to leg in – meaning to buy the stock first and then write the calls later, perhaps days later.

In a buy-write trade, the stock and call legs are entered simultaneously as a combination trade. In a leg-in trade, you would not use a covered call order form, just a trade order to buy the stock.

  1. Order Type. Using a market order to enter the covered call trade generally leads to poor fills, as discussed further on. Many brokers allow the buy-write order to be entered as a combo trade, meaning that you cannot be filled just on one leg of the trade (inapplicable when only buying the stock). Entry orders for covered calls never use a stop or stop limit.

As discussed in more detail below, the better practice is to enter the trade as a limit order specifying a net debit amount as the price. Trying to enter limit prices on the stock and call separately would make no sense, however, because it means chasing the desired fill on two separate securities. It is better to enter a net debit limit price that is acceptable to you. The net debit order lets the market decide where to adjust the price. Of course, the market could rise away from your limit, leaving you unfilled.

  1. Order Duration. As discussed below, you have a choice of duration. The default choice is always a day order. Many brokerages only allow day orders and GTC orders for covered call trades, but this varies by broker. Buy-writers should always use a day order, since there is no way to know for sure when implied volatility will evaporate, taking all the potential return out of a trade – and there is no point writing it once the return is gone. If you are consistently not getting filled on your orders, the solution is not to use a longer order duration, but to increase the net debit limit price specified.
  2. Call Strike and Expiration Month. You must know which call strike and expiration month you wish to sell, and option symbol. The rationales for making these decisions are covered further on. If you are working from a covered call list or scan, it should present the correct call symbol.

Note on leg-in and portfolio trades. If you are already long the stock, you do not use the covered call order form; you typically will use a simple option form (be sure you are selling call options).

Once we know these trade parameters – and only then – we are ready to write the covered call.

>> How To Calculate Covered Call Returns

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