Many investors like to use the covered call strategy to increase cash flow from equity positions that they hold. Covered calls work well on individual stocks and on exchange-traded funds. Some people are not aware that there are issues around protecting a covered call position with a stop-loss order.

SPY

Backing up a step, if you’re not familiar with the covered call, here’s a quick example. Say that you own 100 shares of SPY, the exchange-traded fund that tracks the S&P 500 index. SPY’s price is around $236 per share as of this writing. Let’s say you would be happy to sell it if it hit $240 – this is your price target. (We’re not recommending that particular target – just an example).

You could at this point, sell a call option at the $240 strike price, expiring in a few weeks on May 19, and receive $180 today. Accepting that money obligates you to turn over the 100 shares of SPY in exchange for another $240 per share, if and when a buyer of the option decides to exercise it. That might happen today, or any time before May 19, or not at all. The buyers of the options will not exercise them unless SPY moves up beyond $240. If they don’t, you’ll still have the stock and be $180 richer.

For the moment, you still own the SPY shares. You make money if they go up and lose money if they go down. Your overall profit picture is $180 better than it was before you sold the calls.

Still, you might want to protect yourself in case the price of SPY goes down. Usually this would be done with a stop-loss order – an order to sell the stock if it traded below a certain price, say $230, to stop your losses from becoming larger.

But by selling the call, you have undertaken an obligation to deliver that stock to the call buyer if the call buyer orders it. You can’t also have a stop-loss order to sell the stock to someone else. If you were allowed to do that and the stop-loss order was triggered, you would no longer have the means to meet your obligation to the call buyer. (Some deep-pocketed investors are in fact allowed to sell calls without having the stock to back them up, but we’re assuming that we are not among them).

Fortunately, there is a way to have your call premium and protect your stock position too.

Using a capability called Order Sends Order, together with another called Conditional Orders, will get the job done. Many brokers offer these features. The way it works is to place a conditional order that is not to be triggered unless the stock drops below your stop-loss point. The conditional order is to buy to close the call option that you previously sold. Once that order is executed, your stock is cleared of the obligation to deliver it to the call owner. Attached to that first order, using the Order Sends Order feature, is a second order to sell the stock immediately at the market price.

The effect of the conditional order to buy to close the call, with the immediate automatic follow-up of the order to sell the stock, allows you to essentially create a stop loss on the entire position at your chosen level. This doesn’t cost anything and generally works fine. There may be cases when the stock moves very suddenly and there could be slippage before the entire position is unwound, but that is true of any stop-loss order.

So, now you know that selling a covered call doesn’t prevent you from protecting yourself to the same degree that you could without the call. If you’ve never tried it, consider the covered call as a way to generate extra cash flow on your stock or ETF positions.

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Editors’ Picks

EUR/USD: US Dollar to remain pressured until uncertainty fog dissipates

EUR/USD: US Dollar to remain pressured until uncertainty fog dissipates

Unimpressive European Central Bank left monetary policy unchanged for the fifth consecutive meeting. The United States first-tier employment and inflation data is scheduled for the second week of February. EUR/USD battles to remain afloat above 1.1800, sellers moving to the sidelines.

GBP/USD softens to near 1.3600 as BoE hints further rate cuts

GBP/USD softens to near 1.3600 as BoE hints further rate cuts

The GBP/USD pair loses ground to near 1.3610 during the early Asian session on Monday. The Pound Sterling softens against the Greenback amid growing expectations of the Bank of England’s interest-rate cut. Traders will take more cues from the Fedspeak later on Monday.

USD/JPY drops back below 157.00 on Japan's verbal intervention

USD/JPY drops back below 157.00 on Japan's verbal intervention

USD/JPY has come under moderate selling pressure below 157.00 in the Asian session on Monday. The Japanese Yen lost ground to near 157.70 following Japan’s ruling Liberal Democratic Party's outright majority win in Sunday’s lower house election, opening the door to more fiscal stimulus by Prime Minister Sanae Takaichi. However, JPY buyers jumped back and dragged the pair southward on FX verbal intervention by Japan’s Finance Minister Katayama.


Editors’ Picks

USD/JPY drops back below 157.00 on Japan's verbal intervention

USD/JPY drops back below 157.00 on Japan's verbal intervention

USD/JPY has come under moderate selling pressure below 157.00 in the Asian session on Monday. The Japanese Yen lost ground to near 157.70 following Japan’s ruling Liberal Democratic Party's outright majority win in Sunday’s lower house election, opening the door to more fiscal stimulus by Prime Minister Sanae Takaichi. However, JPY buyers jumped back and dragged the pair southward on FX verbal intervention by Japan’s Finance Minister Katayama.

Gold eyes acceptance above $5,000, kicking off a big week

Gold eyes acceptance above $5,000, kicking off a big week

Gold is consolidating the latest uptick at around the $5,000 mark, with buyers gathering pace for a sustained uptrend as a critical week kicks off. All eyes remain on the delayed Nonfarm Payrolls and Consumer Price Index data from the United States due on Wednesday and Friday, respectively.

AUD/USD: Buyers eyes 0.7050 amid upbeat mood

AUD/USD: Buyers eyes 0.7050 amid upbeat mood

AUD/USD builds on Friday's goodish rebound from sub-0.6900 levels and kicks off the new week on a positive note, with bulls awaiting a sustained move and acceptance above mid-0.7000s before placing fresh bets. The widening RBA-Fed divergence, along with the upbeat market mood, acts as a tailwind for the risk-sensitive Aussie amid some follow-through US Dollar selling for the second straight day.

Top Crypto Gainers: Aster, Decred, and Kaspa rise as selling pressure wanes

Top Crypto Gainers: Aster, Decred, and Kaspa rise as selling pressure wanes

Altcoins such as Aster, Decred, and Kaspa are leading the broader cryptocurrency market recovery over the last 24 hours, as Bitcoin holds above $70,000 on Monday, up from the $60,000 dip on Thursday.

Weekly column: Saturn-Neptune and the end of the Dollar’s 15-year bull cycle

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