M Here's what I see. You BOT X @ 15.00. You SELL and get 16.00 back for a 1 mo. term. Namely, 3.50 (today in premium)+ 12.50 (which is a LOSS of 2.50 on your 15.00 investment)
So, if you PAY out 15.00 to buy "X" in June, and receive, in return,a total of 3.50 plus 12.50 (the in the money strike price you decided on when called out) you are looking at 16.00 anyway you slice it. And that's a buck.
That buck is 1/16th or a 6 2/3 % return.
This is a common discussion. The flaw in your logic is that you don't get the 3.50 at the end of the period, but at the beginning. Suppose I only had $1150. I could still establish this position without using margin using a buy/write. At expiry, if assigned I will receive $1250. My gain is $100 on a capital outlay of $1150, for an 8.7% ROI.
Put another way, what is the maximum loss? I can only lose $1150. It costs $1150 to open the position and I can only lose $1150. $1150 is your investment.
If that still doesn't convince you, what happens to that 3.5 during the life of the option? Is it sitting in my brokerage account collecting money market interest? Did I use it to buy another stock? Did I withdraw it and buy some fun stuff? Wherever it is, it isn't invested in your covered call position so it doesn't count.
If you like math, you'll appreciate the "rule of 72". Divide the interest rate you are receiving (monthly, yearly etc.) into 72. That's how many (months/years it'll take to DOUBLE YOUR MONEY).
That's a great rule of thumb that everyone should know. It's the easiest way to appreciate the power of compounding. The rule itself comes from the formula for computing the future value of an investment that is compounded continuously. Really, you're dividing ln(2) by the rate as a decimal. ln(2) is about .693, so .70 is used as a close approximation. Multiplying by 100 has the effect of changing the .7 to a 70 and the rate from a decimal to a "percent". Using 72 instead of 70 is like making a rough adjustment from continuously compounded interest to annually compounded interest.
M@TMI.pov |
