In a nutshell you sell someone the right to buy your 100 shares of GE at a given time, at a given price for a given fee. For example at the moment (to use real current numbers) you could sell a contract on your hundred shares to sell them at 37.50 in June for $34 (technically $0.34 for each of the 100 shares in the contract).
You get to keep the $34 no matter what happens (minus broker fees).
Past that there are three likely outcomes:
1) The stock rises above its strike price (37.50) and the buyer excercises the option. You sell him 100 shares of stock at 37.50. Your real profit is the $34 fee, plus the difference between the current price and the strike price (which as of GEs last closing would be $2.02/share or $202) minus broker fees (one note--check the fee your broker charges for excercising an option. Etrade, for example, charges 19.99 per contract to both parties when an option is excercised-- which is one reason why you should think twice about writing five cent contracts a day or two before an option expires.)
2) The stays close to its buy price but doesn't go over 37.50 (or doesn't stay there) and isn't ultimately excercised. You keep the $34 fee and your shares.
3) The stock drops significantly. You keep the $34 fee as the option is not excercised--however this is more than offset by the decline in the PPS of the stock.
There are two ways to 'lose' when selling covered calls. The first is that the stock could move significantly above the strike price. You would actually still make money if this happens, but less than you would if you hadn't written the call. May result in you banging your head into the wall.
The second drawback is that you are locked into owning the shares (or at the very least keeping an equivalent amount of money lying around) until the option expires or is excercised. This keeps you from being able to pursue other investments.
Note that you can exit a position by buying an offsetting contract (ie you would buy a call on GE with the same date and strike price) however if the stock has gone up this will cost you more than you made from selling the option in the first place. On the other hand if the stock goes down you can buy an offsetting option for less than it cost you.
Hope that helps.
2007-03-21 17:44:06
·
answer #1
·
answered by Adam J 6
·
3⤊
0⤋
Usually selling covered calls is an income strategy. If you already own the the 100 shares, you can sell or write a call option, which gives someone the option to buy your 100 shares at a certain price. You receive the premium or the price of the option. If the price of the stock rises, it'll probably be exercised and you'll be obligated to sell the shares at the strike price of the option contract. If the price of the stock falls, the option won't be exercised and you'll keep the premium you made on the option except the value of your stock will decrease. Ideally, to make money using a covered call you want the stock price to not move much in either direction so that it's not profitble for the buyer of the call option to exercise or to decrease where you lose on the stock position.
2007-03-21 17:05:14
·
answer #2
·
answered by Anonymous
·
0⤊
0⤋
First, you need to get permission from your broker to trade options.
Second, you need to know what a call option is.
If you need more information on either of these points, read
"Getting Started" and "What is an Option" at
http://www.888options.com/basics/default.jsp
http://www.888options.com/basics/whatis/default.jsp
Then you need to decide which option to sell. There are usually four different expiration months available for any stock, and for some stocks there are two addition long term expiration months available.
In deciding which option to sell, you might want to consider if the option is a "qualified covered call" for income tax purposes. You can get the definition of a "qualified covered call" on page 59 of IRS Publication 550.
http://www.irs.gov/pub/irs-pdf/p550.pdf
Once you have done this you actually sell the call option. When you sell the call option you will receive a "premium" which represents how much someone is willing to pay to buy the option from you. That premium is yours to keep.
After you have sold the option you can close the call option by using a "buy to close" transaction if you want to, or you can choose to leave the option position in place until expiration. If you leave the position in place until expiration, one of two things will happen. If the price of the stock is below the strike price the option will expire worthless and you will have a realized short term capital gain equal to the premium you received when you sold the option. If the price of the stock is above the strike price, your broker will get an assignment notice and sell the stock at the strike price, regardless of the price the stock is trading at on the stock exchange.
The up side of selling a covered call is that you get paid a premium. The downside is that you limit the amount of profit you can make on the stock. The profit graph for a covered call is shown at
http://www.888options.com/strategy/covered_call.jsp
For a real example with GE, today's closing bid for a May call option with a strike price of $37.50 was $0.18 per share. So,if you sold one of these options you would receive $18 less whatever commission your broker charges. That money is yours to keep. If, on the third Friday in May, GE closes below $37.50 the option will expire worthless and no longer exist. At that point you could sell another covered call with a later expiration month if you wanted to. However, if GE closed above $37.50 you would end up selling your 100 shares for $3,750 ... even if it was trading for $40 per share on the open market.
I should note that selling covered call on GE is not very lucrative because the premiums are so small. You will find higher premiums on other stocks because they are riskier to own.
2007-03-21 18:41:31
·
answer #3
·
answered by zman492 7
·
0⤊
0⤋
Your basic understanding of the situation is correct--if your option is called at $750 you'll get strike price $750 - current price $603 x 100 shares/contract= $14,700 plus the $2075 premium for the call for a total of $16,775 (not counting commissions or taxes) a 27.8% return. Now obviously this is a pretty solid outcome. But before you rush off to place an order consider two drawbacks to covered calls: Drawback 1: You limit your upside, without doing anything to limit your downside. For example with AAPL if you sell a $750 call you limit your upside to $167.75/sh (The strike minus the current pps, plus the $20.75/sh you get for selling the call) while you could still theoretically lose $603. Now obviously AAPL isn't terribly likely to go to 0 anytime soon and a 27.8% profit is probably sufficient upside to justify the mismatch. But just keep this in mind... Drawback 2: You could wind up banging your head into a wall when a stock triples and you only see a 20% or 30% gain. Frankly if you sell calls regularly, this will happen sooner or later. And in fact essentially this happened to my father recently when he sold an AAPL $525 for $900 or so. He wound up buying the call back for $2500. Just keep in mind that the opportunity cost for selling calls can be tremendous. I doubt AAPL will double or triple, but I could definitely see a stock that's doubling it's earnings and selling for a PE under 20 going up more than 30% in the next 10 months. If this happens you'll make money, but not nearly as much as you otherwise would.
2016-03-28 23:08:48
·
answer #4
·
answered by Anonymous
·
0⤊
0⤋
Another possibility would be, if the stock goes above the sold calls strike price, would be to buy it back and sell another further out and hope the stock cycles down in the next round.
2007-03-21 18:58:40
·
answer #5
·
answered by Anonymous
·
0⤊
0⤋
Sell to open 1 contract (represents 100shs)
Collect premium.
Stock stays put or goes down in price until expiration period.
Holder will not exercise to buy with your contract strike price when he can buy stock cheaper in the market.
Option YOU wrote expires worthless to holder (buyer).
Your position closes at expiry.
You retain premium.
The third contingency is critical, of course.
2007-03-21 17:06:32
·
answer #6
·
answered by Showbizzz 2
·
0⤊
0⤋