Thanks LG - just a recap for others…. I just rea
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Posted On: 07/16/2021 6:00:25 AM
Re: LegendayGoat #50441
Thanks LG - just a recap for others…. I just read up on this and figured I would share…
Covered Call Example
An investor owns shares of hypothetical company TSJ. They like its long-term prospects as well as its share price but feel in the shorter term the stock will likely trade relatively flat, perhaps within a couple of dollars of its current price of $25.
If they sell a call option on TSJ with a strike price of $27, they earn the premium from the option sale but, for the duration of the option, cap their upside on the stock to $27. Assume the premium they receive for writing a three-month call option is $0.75 ($75 per contract or 100 shares).
One of two scenarios will play out:
TSJ shares trade below the $27 strike price. The option will expire worthless and the investor will keep the premium from the option. In this case, by using the buy-write strategy they have successfully outperformed the stock. They still own the stock but have an extra $75 in their pocket, less fees.
TSJ shares rise above $27. The option is exercised, and the upside in the stock is capped at $27. If the price goes above $27.75 (strike price plus premium), the investor would have been better off holding the stock. Although, if they planned to sell at $27 anyway, writing the call option gave them an extra $0.75 per share.
Covered Call Example
An investor owns shares of hypothetical company TSJ. They like its long-term prospects as well as its share price but feel in the shorter term the stock will likely trade relatively flat, perhaps within a couple of dollars of its current price of $25.
If they sell a call option on TSJ with a strike price of $27, they earn the premium from the option sale but, for the duration of the option, cap their upside on the stock to $27. Assume the premium they receive for writing a three-month call option is $0.75 ($75 per contract or 100 shares).
One of two scenarios will play out:
TSJ shares trade below the $27 strike price. The option will expire worthless and the investor will keep the premium from the option. In this case, by using the buy-write strategy they have successfully outperformed the stock. They still own the stock but have an extra $75 in their pocket, less fees.
TSJ shares rise above $27. The option is exercised, and the upside in the stock is capped at $27. If the price goes above $27.75 (strike price plus premium), the investor would have been better off holding the stock. Although, if they planned to sell at $27 anyway, writing the call option gave them an extra $0.75 per share.
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