# Selling Covered Call Options Question?

Let's say I want to sell a covered call with a \$750 strike on Apple with a January 2013 expiry. I collect my premium of around \$2000. I sit and wait. The stock closes at \$760 in October, and my shares get called away. I am not now selling my 100 shares at \$760, representing an \$18 000 profit? Where is the downside of selling calls? If they called away because the strike is met, does it not simply mean guaranteed profits?

Relevance
• 8 years ago

The downside of CC writing is that you limit your gains if the stock takes off and goes above your strike + premium. ( If the stock goes down, you make on the option premium, but that could be a very small consolation prize compared with the principal loss. )

For example, I buy AEP ( American Electric Power at \$38.48. I then write a CC at \$40 strike, for 25 cents, expiry August 2012. Let's say the stock goes up in the next 2 weeks to \$41. I will get exercised and lose my stock just before the next ex-div date. Thus, I lose a 45 cent dividend and price of the stock over \$40 ( in this case, \$1 ) - my CC has cost me \$1.45 for a gain of 25 cents.

Lv 6
8 years ago

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.