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Strategies & Market Trends : The Covered Calls for Dummies Thread

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To: JohnM who wrote (1147)	6/20/2001 11:05:36 PM
From: FaultLine	Read Replies (1) of 5205

JohnM, You are not going to get called -- at least not yet. When you sold the calls at 2.15 that was all time premium. The intrinsic portion of the call was 0.00 because the stock was below the strike and so there was no built-in value to the call , just a potential, a possibility that the call would eventually be more valuable. That potential is the 2.15 in time premium that you received. Today the situation has changed. The stock is quoted at about 41.40 and the call at 4.20 options.nasdaq.com So we see that we are 1.40 above the strike -- that is the intrinsic value of the call. Now, since the total premium is 4.20 and the intrinsic portion is 1.40 then the remaining time premium (the probability of future growth) is 4.20 - 1.40 = 2.80 so the possibilities for growth are considered by the buyers and sellers as increasingly optimistic. At this point the call holder could sell the call back for 4.20 and keep the profit over whatever the originally paid. Anyone selling JUN 40's today will get 2.80 in time premium as opposed to the 2.15 you received. But what if they decide to exercise today instead? It seems like they could exercise at 40 and immediately sell for 41.40 and turn a 1.40 profit...except for one small detail...they had to buy the call first. They would have paid you or someone else 2 or 3 for the call awhile back and then today they would have to pay you another 40 for the stock. Well heck, that totals up to 42 or 43 dollars which is more than the stock can be sold for on the open market. So, whenever there is still some time premium in the call, it make no sense to exercise because the exercisee will lose money. Only when there is about 1/8 of a point or less left in time premium do you need to worry about exercise. This is not to say that some misinformed call holder won't make an irrational decision to exercise -- it just is not a rational decision. They should always sell the call rather than exercise as long as time premium remains. That time premium will bounce up and down a bit but overall it will inexorably slide toward zero as we approach expiry in mid-July. I see GMST trading up and down between 35 and 45 since mid-April. I'd bet it will fall back over the next couple of weeks and you will be able to gracefully, and profitably, buy-to-close at less than the 2.15 you received. Please be understand that this is just my opinion and not advice to buy or sell anything. --dfl

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