There are a few "bad" situations - some of which are of your opinion and others which range from "bad" to "really bad".
If you buy a stock simply to sell covered calls on it, you already are aware of the upward "bad" event - that the stock will move up in price, and if the stock's price is above the strike price (on expiration day), it will be bought away from you. (BTW the risk is almost zero that it will be called away from you before expiry). But, if you bought the stock simply to get the premiums, you take that "risk" because you like the $$ you are getting from selling the calls - the $$ are kind of like getting interest. So, this circumstance is only bad if you really wanted to hold onto the stock - in that case you would not fully understand what selling cc's is.
The other scenarios range from bad to worse. If you have bought the stock simply to collect premiums, there is the risk that the stock stock will drop so much that the next month's options (assuming you play them month by month), with a strike price equal to those you sold in the current month, can only be sold for a lesser amount OR a pittance, - and you are stuck with the stock until it rises in price again. You may have very little to offset your cost of holding during that waiting period.
But, if you are comfortable with buying the stock at your initial purchase price, possibly being stuck with it for an indeterminate amount of time, or having it bought away from you, then you pretty well understand the risks associated with selling cc's - the risk is that they fail to capture for your pocketbook all upward movement in a stock's price.
The case of the stock dropping in price is not a risk of cc's - it is a risk of stock ownership, which the premium from the cc's does something to ameliorate.
Best,
Jeff Smith |
