<<can you explain the strategy of the covered call by using an example.>>
Caveat-Long, off topic reponse about options, skip if you aren't interested.
Since no one has responded to your query and since I have written covered calls some myself I'll give it a shot though I will not present myself as some sort of expert.
NTAP closed Friday at 148 5/8. With the run up I do not see November calls for the 145 and 150 strike prices listed yet but they should become available next week. We will have to use the 140 calls. Usually you would write a call closer to the current price, preferably out of the money.
Say I have 100 shares of NTAP. The Nov 140 Call (symbol ULMKH) closing bid price was 19 so I am going to sell one contract for $1900.
What happens come the third Saturday in November? There are many possibilities but let's look at a few (commissions and taxes not included):
#1 NTAP is trading at 140 or less. Boo. However, the options expire worthless and I keep all the $1900. Yippee!
#2 NTAP is still trading at 148 5/8. Close to expiration the option is now worth 8 5/8. I can either buy back the option making $10 3/8 or $1037 on the contract, keep the stock and write another call next month, or I can let the stock get called away at a price of 140 but the effective price is $159 (strike price $140 plus the option premium of $19). That is a return of [(159-148 5/8)/148 5/8] or nearly 7% in a month on your money whether I let the stock get called away or I buy the options back. Not a bad return.
#3 NTAP is trading at 160. The 140 call is now worth $20. I can either let the stock get called away at an effective price of $159, giving up any gain above 159, or I can buy back the option at a loss of a a dollar per share or $100. But remember I keep that gain (on paper) from 148 5/8 to 160 for the stock.
This isn't the best example because there aren't out of the money calls available just yet. The option premium for OTM calls is less, but the risk of getting called out is less and the price of the option represents time premium entirely, no intrinsic value. Time is on the side of the option seller.
Why would one write calls? For the income as in #2. To sell at a predetermined target price as in #3. To protect against a decline as in #1. Note in the above example that NTAP can fall all the way to 129 5/8 (148 5/8 - 19) and you would be at least as well off having sold the option as you would be if you had sold the stock at 148 5/8. If you are lucky in the timing it makes gut wrenching declines in volatile stocks like NTAP easier to take.
I don't currently write calls because I intend to hold stocks like NTAP for the long haul. I don't want to risk being called out, miss a big run up in price and then, adding insult to injury, have to pay taxes. You also have to be good at timing these sort of trades and I haven't been.
However, with nearly all my holdings being G&K stocks or candidates that pay little or no dividends I am rethinking the income generating approach as I contemplate trying to live off my portfolio in the future. If I was getting 7% a month from my holdings I would be writing this from a condo in Maui.(g)
Sorry to be so long winded. I am sure I have tried the thread's patience and will return to lurking. |
