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?

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  • 8 years ago
    Favorite Answer

    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.

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  • Adam J
    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.

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  • JoeyV
    Lv 7
    8 years ago

    The downside is that you should be thinking in terms of your portfolio in which you will have winners and losers. If you give away all the profit on your winners but keep all the losses on your losers, you will go broke.

    But I think selling that call on AAPL is a pretty cagey move. Not that I like to bet against AAPL, but that's selling at an excessive vol IMHO. AAPL getting a little "bubbly"....

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