Selling call option- conservative approach of collectin premium question?

Question

One sells a call option and simply wants to collect the premium each month, provided that the stock doest hit the strike price-
I have not done this but this appears to be basic. Anyway, when I look at stocks to sell call options I notice that most of the strike prices are below the current market value, strike prices that are lower. for example the may 30 call for csco is paying .o5? such a small prem. There is a may 25 for 1.70.. My question BUT there is an excellent chance that this is going to get exercised as the stock is above the 25. Please clarify this. I thought it is better, when selling a call, for the stock to stay at the same price.. Can someone give a few examples of selling a call with the CSCO prices I just gave. THANKS!

Answer 1

Remember, to be able to sell an option there has to be someone willing to buy it. Since $30 is well over the current price of CSCO stock, above its 52 week high, there is little chance of CSCO ending up over $30 by the third Friday in May. As a result, no one is wiling to pay very much for it.

You are correct that if you sell the May $25 call here is a good chance you will sell your stock for $26.70 ($25 + $1.70)per share. That if he stock price does not change between now and the third Friday in May that would be a good thing since you could buy back the stock for less than that amount, leaving you with a profit. If the stock price is below $25 per share you will keep the entire $1.70 premium, leaving you in better shape than if you had simply held the stock and not sold the call. If the stock is above $26.70 per share at expiration, you would have been better off if you had simply held the stock and not sold the call. (That is sometimes called oppotunity risk.) If you would not be happy to sell the stock for $26.70 per share, you probably should not sell the $25 call option for $1.70.

I am not as enthusiastic about selling covered calls as some people are. During a bull market you will often find that even though you sell a stock for a profit, you would have had a larger profit if you had not sold the option.

You are correct that selling covered calls, like most strategies where you sell options, works well when the price of the underlying does not change very much.

CSCO is probably not the best cadidate for a covered call strategy because the premiums are low. If you look at the premiums for most other stocks you will find they are higher.

Addendum to sky_bluegreen:

To calculate the "time value" first you calculate the intrinsic value. with the stock at $25.98 and the strike price at $25.00, the intrinsic value is

$25.98 - $25.00 = $0.98

To get the "time value" you subtract the intrinsic value from the option premium, in this case $1.75

$1.75 - $0.98 = $0.77 time value.

Addendum to QUES:

You are correct that if assigned he would sell the stock for $25.00. However, since he had already received $1.70 for the option premium, the total he received would be the sum of those two figures, or $26.70. The person who sells the call does keep the premium whether assigned or not.

Addendum to rt67856

Let me try to explain my showing what happens in a portfolio that starts with 100 shares of CSCO.

$2,589 = value of CSCO stock
+ $000 = cash
----------
$2,589 = value of portfolio

Now you sell 1 call options for $170.

$2,589 = value of CSCO stock
+ $170 = cash
- $170 = value of short option
----------
$2,589 = value of portfolio

Selling the call did not change the value of the portfolio. However, if the option is exercised the portfolio will be

$2,500 = cash received from the stock sale
+ $170 = cash received from the option sale
----------
$2,670 = value of portfolio

If the stock was still selling for $25.98 you could them spend $2,598 to buy 100 shares and have $72 left over

$2,589 = value of CSCO stock
+ $072 = cash
----------
$2,670 = value of portfolio

The portfolio is now contains $72 in cash it did not have originally, the profit from the covered call.

Answer 2

Options have two values to them.
1) Time value....the amount of time an option has left until expiration. The more time an option has the more valuable it is.
2) Intrinsic value....the amount that the option is already above the strike price.
Example:
As of this writing, CSCO is trading at 25.98 down .36 from yesterday. So, the stock is above the 25 call price by .98
The intrinsic value is .98.
The time value is about .77
So .98 + .77 = 1.75 the cost of the 25 call option
There are 52 days left until expiration. As expiration approaches, the time value will erode...always will. The intrinsic value may go up or it may go down. Just depends where the stock is trading as expiration approaches.
The reason for the small premium on the 30 call is because CSCO would have to move above 30.05 within 52 days before that call would be profitable. In most cases, the odds of that happening are slim to none, hence the low premium.
A lot of brokerages won't let you sell naked calls or puts. It seems basic and easy, but you can loose your butt in a heart beat. You need to have an exit, damage control, plan in place before you place the trade.
Here is a trading system you might be interested in.
http://yoteez1.clickb4nk.hop.clickbank.net/
Be careful with options. I have made lots of money with them and I have lost a lot also. I lost $63,000 in 3 days back in 2000 with options so learn from the experts before jumping in.
I was just playing them blind with no clue of what to do.

Answer 3

It is better when that the stock remain at the same price when selling a call option. In fact that's why you would "sell" a call option when you own the underlying stock. Your betting the stock will stay in a range, otherwise you would have no reason to write a call on your stock.

Now the person who bought the call might have different reasons for buying and paying the premium. One factor in that premium is time, quite a bit can happen to the market, or individual stock within a month. Another factor is hedging a bet. If a person is short a stock, well to minimize any unforseen upside they would purchase a call. Another reason might be leverage, that's a small amount of money to put up, $170 for 100 shares vs $2,500 for the same shares of stock.

Now some other reasons are psychological. There are enough holders of csco stock to provide some volume in the options, so at any 1 time you might have a guy shorting, heding, going long, or someone who writes a call on his underlying stock because he believes that within the next 30 days the stock is going nowhere so why not pocket a little premium to reduce cost per share. On the opposite side of that scenario, the guy buying the option might be covering his butt as he goes short on the stock, or someone who believes something big is going to happen this month etc.

Answer 4

((((ZMAN492))))
I have been following this thread. New at options. Please help, an issue with your answer.

If the poster sold the May $25 Call- say it got exercised at 25- you say 25+1.70) Thought it was just the 25 since he keeps the premium... Anyhow- You said that if the stock price does not change between now and the third Friday in May that would be a good thing since you could buy back the stock for less than that amount leaving you with a profit... I am totally lost with that statement. Please explain. CSCO is currently trading at 25.98- if expiration comes it is exercised since the strike was 25...So, if the stock price does not change, that is if it stays at 25.98,, it is not good- right? as the call seller loses the shares? Am I missing something? please explain How is he going to buy back the shares at a lower amount if he already lost them?

Again, I am just learning how to sell call options and any help you can provide to help me understand this concept will be greatly appreciated.

They say selling covered calls is conservative and can generate some monthly income- But the stocks that I see that pay big premiums all have stock prices that are higher than the strike price- thus the seller will have to give up his shares..are there examples where the share price is lower than the strike with a decent premium? THanks for your patience

Answer 5

hi, question: ZMAN492-
If he sells the May 25 call and it gets called- it sells for $25- you stated 26.70 , I thought the person who sells the call- gets to keep the premium- no matter what, please explain,

Answer 6

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I describe and track my own covered call trades. It sounds easy but takes some work.

Answer 7

BW- Time value is about .77- can you show us how you got that number, I am confused. THANK yoU