HOW TO WRITE COVERED CALLS - A REAL CASE STUDY!
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PAGE #5 Date: Monday, Feb. 10, 1997
The stock: ROSS STORES (ROST) Last traded at $45.00 up 1 on Mondays'
close. 2 for 1 split - Record date Feb. 11, 1997! Will also increase
dividend also! Note - Heavy down day volume today!
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GETTING INTO A POSITION:
Today we purchased two (2) MARCH 40 Strike Price at a Limit Buy of 6 1/8 each. The total for the two contracts with $40 commission came out to $1,265.00 of some dude's money that I collected and happen to have in my slush fund!
I originally placed a limit buy at yesterday's close of 5 5/8 per contract but the
market opened and the option quickly pegged 6 1/8 and actually reached a high of 6 1/4 for the day. So, we did not do so bad moving into position. I choose to buy ROSS calls rather than taking a position in the stock itself. I'm in the process to trying like heck to get called out of some other stocks so that I can roll those profits into ROSS Stores stock before the ex. div. date of March 10, 1997 of .045 to be paid on April 07, 1997.
I would like to take this time to discuss the reasons why I picked the March 40
Strike price. Most people would go for the March 45 strike price. Indeed, if you take a look below at my cut and paste from my spreadsheet template (I call OPTCALC for Option Calculation) you will see the ask prices and the open interest to the far right side.
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.................................... SPECIFIC OPTION PRICE VS. VALUE
.....................................................................................................................OPEN
..MTH STRIKE.$........ ASK $.......PREMIUM.$ INTRINSIC VALUE $... INTEREST
-------------------------------------------------------------------------------------------------------------------- 1 *...MARCH.....40.........6 1/8.......... ($1.13)............$5.00..................................122............
2......MARCH.....45.........3 1/4.......... ($3.25)............$0.00..................................572............
3......MARCH.....50.........1 1/4.......... ($6.25)........... ($5.00)................................18................
INTRINSIC VALUE EQUALS: STOCK PRICE $45 - STRIKE PRICE $40 = $5.00 IN THE MONEY!
PREMIUM VALUE EQUALS: WHAT YOU PAID $6.125 - INTRINSIC VALUE $5.00 = $1.13
So, for you to break even you option must appreciate to 6.125 + 1.13 = 7.26
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Some of you will find this information very basic, but not everybody is acquainted with the subject. So. bare with me today.
Listed above are bits of information that I gathered from my screen this morning when I was deciding which calls to purchase. I could have purchased the February Calls, but, I don't want to own the stock at this time and the Feb. expiration date was too close! I just want to LOCK IN THE 2-1 OFFER for the split and sit tight for a few weeks. These two contracts will eventually provide me with right to purchase not two hundred shares, but, 400 shares at half of the current strike price at $20. Why, because the 2-1 split impacts the calls also. In this example the $40 is cut in half to a $20 strike price and the number of shares of stocks goes from 100 to 200 each x 2 = 400s shares. It doubles see?
I always try to write more than 3 contracts every turn I can. Yes, that means that I own at least 300 share of each stock I own. Reason, the commissions are lower as a percentage of each transaction. ie. covering, writing calls.
There are some very important factors that you must consider when buying calls. They are:
INTRINSIC VALUE - It is the cash value of the option or simply the amount by which an call option is "in the money."
PREMIUM - The real cost of the option to you! It is the option's time value. The intrinsic value is an even swap dollar for dollar, but, this part is the real price tag! Once your option appreciates over it's value you are making a profit! The other two are just too high. $3.25 and $6.25 price tags is a bit steep for me. Besides, I'm using some other dude's money (covered call premiums) to pay for this move. I'm sure they won't mind!
Now, I don't know about you, but I rather be "in the money" making money as soon as possible before the momentum starts to drop off. That way, I can write a NICE FAT COVERED CALL at the stock's resistance level and watch the stock ROSS profit taking eat up my call buyer's money. Of couse, I will be waiting to cover my call (when 80% of the value is gone!) at a much lower price and wait for a stock price rebound and write another covered call.
On other comment! In the money calls appreciate much faster and the option value move more inline to the stock price moment than an out of the money call. I use my template which calculates my possible exit points. Check out my chart with the profit/loss estimator for the two ROSS March 40 Calls Information:
QUICK PROFIT/LOSS ESTIMATOR
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TARGET.. SELL..@... $ GAIN....... PROFITS
3.................. 9 1/8........... $275.00...... $550.00
2 7/8........... 9...................$262.50...... $525.00
2 3/4........... 8 7/8........... $250.00...... $500.00
2 5/8........... 8 3/4........... $237.50...... $475.00
2 1/2........... 8 5/8........... $225.00...... $450.00
2 3/8........... 8 1/2........... $212.50...... $425.00
2 1/4........... 8 3/8........... $200.00...... $400.00
2 1/8........... 8 1/4........... $187.50...... $375.00
2...................8 1/8...........$175.00...... $350.00
1 7/8........... 8...................$162.50...... $325.00
1 3/4........... 7 7/8........... $150.00.......$300.00
1 5/8........... 7 3/4........... $137.50...... $275.00
1 1/2........... 7 5/8........... $125.00.......$250.00
1 3/8........... 7 1/2........... $112.50...... $225.00
1 1/4 ..........7 3/8........... $100.00.......$200.00
1 1/8........... 7 1/4........... $87.50.........$175.00
1...................7 1/8........... $75.00.........$150.00
0 7/8........... 7...................$62.50.........$125.00
0 3/4.......... 6 7/8 .......... $50.00.........$100.00
0 5/8........... 6 3/4........... $37.50.........$75.00
0 1/2 .......... 6 5/8........... $25.00.........$50.00
0 3/8........... 6 1/2........... $12.50.........$25.00
0 1/4 .......... 6 3/8........... $0.00...........$0.00
0 1/8........... 6 1/4........... ($12.50).....($25.00)
0.................. 6 1/8........... ($25.00).....($50.00)
-0 1/8......... 6.................. ($37.50)......($75.00)
-0 1/4......... 5 7/8........... ($50.00)......($100.00)
-0 1/2......... 5 5/8........... ($75.00)......($150.00)
In closing, if you can afford the extra up front dollars for the call do it! If you ever consider daytrading options, pick only in the money calls for quick profits! I always place limit buy order when purchasing options for myself! An 1/8 to1/4 point can sometimes mean the difference between a profit and a loss if you try sell the call.
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