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Strategies & Market Trends : The Covered Calls for Dummies Thread
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To: JohnM who wrote (814)5/26/2001 10:59:38 PM
From: BDR  Read Replies (2) of 5205
 
<<Before that time point, the stock price would need to be well above (say, 2 or 3 points) the strike price before someone would call. Sound right?>>

I was referring to being called out at expiration. Before expiration you are unlikely to be called out but it can happen at anytime and it isn't directly the result of how far in the money the calls are. With an in the money call the price of the call represents both the intrinsic value (stock price - strike price) and the time premium (call price - intrinsic value). If the time premium vanishes then it is equally advantageous to the holder of the call to own the shares or the calls. If the premium of the calls dips down for whatever reason such that the premium plus strike price is less than the stock's price the holder is better off exercising and you likely will get called. You have no control over this since you gave up that right when you took the other guy's premium.

How do you know if you are at risk of being called? If your stock is in the money look at the premium for the call you have written. Say NUFO is at 16 and you have written the June 15s. If the bid is 1.50 (1.00 intrinsic value + .50 time premium), the holder of your calls could sell the calls and make 1.50. If he exercised those options he could buy the stock for 15 and sell it on the open market for 16. Net 1.00. He would be .50 better off to just sell the calls.

Now, if the bid momentarily drops to .75, he gets .75 for selling the calls. But if he exercises he can still buy at 15 and sell at 16, netting 1.00. Now it is .25 to his advantage to exercise. Mere mortals like you and me are not likely to be able to jump on the small price discrepancies that make this type of trade profitable but, believe me, there are lots of professionals out there looking (actually their computer programs are doing the looking) for such arbitrage opportunities.

Usually there is enough time premium built into the price to prevent this from happening. But remember that the time premium decays rapidly as expiration day approaches and with a volatile stock such opportunities could develop. It is unlikely that you would have to worry about early exercise weeks before expiration, but just days before you might want to be careful. I hope that helps.
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