Nifty Covered Call Strategy

  • Jun-16-2020

Covered call is one of the widely used Option Trading strategy to generate a income month on month. Where we simply buy the underlying and short OTM options. The expectations behind Covered Call strategy is Market usually moves up like a snail and drops like a stone.

In this article, we will Buy Nifty Bees and Short OTM options of Nifty. That’s how a Index movements will be, it gradually moves up, so if when short OTM Call options and Nifty doesn’t make any wild up-move, our OTM options expire worthless and thus providing a profit for the trade. Even if there is a up-move, since we already hold the Nifty bees positions, the losses from shorting OTM calls would be offset by profits made by Nifty bees holding.



First we need to gather Nifty historical data and see how it performed month on month for last 10– 12 years to know the volatility of the index. So I checked the monthly returns of Nifty index from 2007 to 2020. This is how the scatter plot of returns looks like, as you can see most of the time Nifty movement was between -5% to +5%, it oscillated between this range only mostly. Out of 174 months, only 38 times, Nifty made more than 5% up move which means 80% of the time, if you short OTM call options that are 5% away, it would expire worthless and generates a income for you.

Out of 174 months, only 9 times, Nifty made more than 10% up move which means 95% of the time, if you short OTM call options that are 10% away from underlying, it would expire worthless and generates a income for you every month. But remember these far away OTM options will have lesser premium.

So we need to find out a optimal strike and keep shorting it every month. So that we get good premium. We considered OTM call options that are 3% away from spot, every month at the start of new expiry, we check this strike and short it.

The covered call strategy has given positive returns when tested with the 12 years of historical data, generating positive returns year on year, with only 2 years negative. Years like 2008 when the market tanked badly, options that we sold has yielded positive returns offsetting most of the losses we incurred by buying Nifty.

Conclusion:

If we had invested only in Nifty we would have got 4.5 lacs profits, but with covered call strategy, we can pledge this Nifty that we bought and use that to short call options every month, so that it can generate additional returns over the years, where it generated additional 1.12 lacs with this strategy. So covered call is really a viable strategy to generate additional returns over the long term, provided we choose the right strikes, too far strikes might not have enough premiums, choosing the right strikes helps. 

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Lets us know what do you think about Covered Call strategy in the comments section


  • profile
    Anil Bhasein
      1 week ago

    How many units of nifty bees will be required to hedge our position ??

    Reply 0 comments
  • profile
    K V Rao
      2 weeks ago

    For 8, 00, 000 investment in Nifty bees, we will get margin to sell 6/7 lots. So, I will sell 7 lots 10%away calls.

    Reply 1 comments
    • profile
      Square Off
        2 weeks ago

      yes, you can do that, but if its not equivalent lots, then its not covered call

  • profile
    Rahul Ostwal
      2 weeks ago

    3% away OTM can become ITM in a week in current market situation.

    Reply 1 comments
    • profile
      Square Off
        2 weeks ago

      we tested with 5% away , even 10% away, it has given bad results.

  • profile
    ravindar jayachandran
      2 weeks ago

    Nippon niftybees one must have 7500 (value appx 8 lakhs at current market price) to do this right? As when you sell 3% up from current nifty index you can sell 1 lot of say 10400. Is my understanding correct. The statistics provided by you - is it based on one lot? Kindly clarify

    Reply 0 comments
  • profile
    Ranganath sr
      2 weeks ago

    Can I have your code used for scatter plot

    Reply 0 comments
  • profile
    user Bourn
      2 weeks ago

    Marvelous

    Reply 0 comments
  • profile
    mihir joshi
      3 weeks ago

    Can you please get some time to test thr same strategy on weekly options

    Reply 1 comments
    • profile
      Square Off
        3 weeks ago

      Weekly option is introduced only from Feb 2019, hence we tested with monthly options from 2008.

  • profile
    Tushar Kadam
      3 weeks ago

    When nifty is down-10% for current month still nxt month you will be selling 3% otm call? Or from the brought price?

    Reply 1 comments
    • profile
      Square Off
        3 weeks ago

      Yes, we sell 3% away from spot price

  • profile
    K V Rao
      3 weeks ago

    Also, with new margin Rules, more opportunities. I would sell 10% away strikes multiple Lots. will give better Returns. Alternately, I will buy 10% away strike current month and sell same strike next month

    Reply 2 comments
    • profile
      K V Rao
        3 weeks ago

      It will reduce margins

    • profile
        3 weeks ago

      How buying 10% away strike and selling next month would help

  • profile
    Vivek Jain
      3 weeks ago

    From risk profile, Writing Covered Calls is same as writing Naked Puts (i.e Underlying + Short Call = Short Put), So, better to go for Short puts as ROI much better

    Reply 3 comments
    • profile
      Vivek Jain
        3 weeks ago

      Covered call is equivalent to naked short put. No more risky, no less risky. So Long Nifty Futures + Short CE 10500 = short PE 10500. This is the veru basic of Synthetic Options. Lets not forget that in covered Call, one is holding the underlying (Nifty Futures in our example) - so when market tanks - one is loosing on the underlying as much as market fall

    • profile
        3 weeks ago

      But when mkt falls, it falls like stone...so does not it become more risky than shorting call?

    • profile
        3 weeks ago

      Wow .. u made it simple

  • profile
    Parin Shah
      3 weeks ago

    How much capital required?

    Reply 2 comments
    • profile
      Vivek Jain
        3 weeks ago

      Its much more efficient and better use if capital to buy Futures instead of Actual stock (Bees in this case). Much lower STT/taxations, lower initial capital. Even after factoring in costs for rolling futures every 3 months it is much cheaper. Do the math and you will understand yourself.

    • profile
      Square Off
        3 weeks ago

      You need to have minimum 7.5 lacs to execute it considering Nifty at 10000 levels

  • profile
    Harikishan Thirividi
      3 weeks ago

    Looking forward from you to receive the automated Bot with Covered call stratergy

    Reply 0 comments
  • profile
    Navaneetha krishnan
      3 weeks ago

    How much quantity niftybees do I need to do covered call ?

    Reply 1 comments
    • profile
        3 weeks ago

      7500 nifty bees


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