"Deep ITM Covered Call On Indexes?"

Select Your Language... Translate to Chinese Translate to Spanish Translate to French Translate to German Translate to Italian Translate to Portuguese

"Deep In The Money Covered Call On Indexes?"

"I read about deep in the money covered calls. I want to know Can deep in the money covered calls strategy should also be performed on indexes inspite of stocks, should I buy index futures and sell deep in the money covered calls?"
Asked By Nikhil Gupta on 11 April 2012

Answered by Mr. OppiE

Hi Nikhil Gupta,

Yes, Deep In The Money Covered Calls can be used on any instruments with options but to use Deep in the money covered call on an index would require careful choosing of the underlying instrument representing the index.

Apart from Index Options, there are really two main ways to have a position on an index; Index Futures and Exchange Traded Funds (ETF).

Index futures are futures contracts with indexes as their underlying instrument. Like index options, index futures are derivatives of indexes and has multiple expiration months and requires margin. The problem with using index futures as the underlying instrument for an Index Deep In The Money Covered Call is that firstly, index futures don't move exactly the same way its underlying index moves. In fact, it could even go down when the underlying index goes up! This will result in the index futures not moving exactly the same way as the call options and result in imperfect hedging or even unexpected losses. Remember that the hedging and protection of the Deep in the money covered call comes from the fact that the call options move dollar for dollar with its underlying instrument when the instrument is trading above its strike price. Using index futures in combination with index options would not provide the perfect dollar for dollar movement. Secondly, unless you are writing options on futures offered by the specific index futures you are trading (and only IF such options are offered by the futures), you will have to write index options while going long on the index futures. This not only means putting on a naked call write position which requires high margin as the broker would not see the options and the futures as a composite position, and also requires the highest options account trading level which isn't available for everyone. So you will be paying margin for the futures position and seperately holding up some more funds in your account for margin required by the short call options. This is completely different from the no margin needed deep in the money covered call position.

The other way is by Exchange Traded Funds or ETFs. ETFs are funds created based on the stock composition of an index, move as closely as possible to the movements of the index itself and can be bought and sold just like a stock in the stock market. Some examples of ETFs are the QQQ and INDY. The QQQ is an ETF based on the Nasdaq100 index and INDY is an ETF tracking the Indian Nifty 50. In today's global market, there is an ETF for almost every major index in the world. The good thing about ETFs is that they are securities, not derivatives like index futures and index options. They are securities that can be held and owned without margin and can be owned perpetually so you can hold on to them like stocks for as long as you like. Another good thing about ETFs is that they usually have options available for trading as well! So you can actually buy the ETF and then sell deep in the money call options to make a deep in the money covered call the exact same way you would for any stocks! This will overcome the problem of margins as well as imperfect tracking since the options are offered directly by the ETFs themselves.


In conclusion, there are a few ways to do deep in the money covered call for indexes but the way I would recommend most retail options traders would be to do so through an ETF based on the index you wish to trade. This is both convenient and avoids many of the problems that other instruments such as index futures and index options pose.