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Strategies & Market Trends : How To Write Covered Calls - An Ongoing Real Case Study! -- Ignore unavailable to you. Want to Upgrade?

To: Esteban who wrote (6465)	1/16/1998 3:41:00 PM
From: Greg Higgins	Read Replies (1) \| Respond to of 14162

I think this forum could use an in depth discussion of assignment and expiration strategies. Some people sound at times as if they think that having the call over the strike price at expiration is an instant loser. This is not true. It's also not true that buying the call back for more than you paid for it is a losing strategy. From where I sit, there are three possible "end game" situations which all call sellers need to plan for: 1) It's expiration day and you want to be assigned. 2) It's expiration day and you don't want to be assigned. 3) It's not expiration day, but some jerk just exercised his options and you get assigned. The first case is trivial. You sit and do nothing; you'll either be assigned or not depending on the closing price. Whether to go short or to surrender stock you own is a separate decision. I would go short if I was long stock since I can always cover from my current position. Note that if you decide to go short, you may not necessarily be allowed to write calls against the stock you hold long. The second case can seem more complicated, but it's really not. It doesn't matter whether the stock is 1/8 or 100 1/8 over the strike price. If you don't want to be assigned, the only thing that's important is whether or not next month is selling an option for the same strike price. If it is, you buy back this month's call and sell next month's call. You will always get more for next month's call than you will spend for this month's call (unless you're involved with selling calls for 1/16 or so, a practice not covered by this missive.) You might even be able to enter it as a single net credit order with your broker. Doing this pushes the problem out further in time, giving you more time to deal with the "problem" of a rising stock. It also gains you more premium. This is not always the best thing to do, particularly if your stock is rising and never coming down. But it is possible to do almost all the time. If your stock has risen so far that next month won't have your strike price, you could look out to the future months and see if they have your strike price. Generally they will, but this is a two edged sword, by going out several months, you're giving the stock time to rise even further above your strike, but you're also giving it time to return to more reasonable levels. If this is the last month of your strike however, you can choose how fast you want to recognise your "potential loss" by simply buying back your calls and selling the deepest in the money calls available for next month. This generally involves an amount of money which is much less than the loss which would be taken if you had to buy and sell stock. Some people might claim that all of this doesn't make sense, and it might not from the short term perspective. But if you bought KO 20 years ago, and you're currently selling calls against that stock, you don't want to give the stock up and you should do everything you can to protect yourself from giving it up. But that doesn't mean you need to recognise a loss immediately. Situation number three is the most problematic. In a rational world a call option is only exercised early if the value of the dividend on the stock is worth more than the interest available on the strike price between the ex-dividend day and the option's expiration date. Generally you're supposed to be able to see this coming -- the option will start to trade at or below parity. If the stock's at 29 and the 25 strike option sells for 4, that's parity and an exercise is imminent. But the world is not rational. Someone could theoretically decide to exercise their option early, even though it may be worth more sold than exercised. If it does get exercised and you get assigned, you have little time to decide what to do, so you should know in advance what you want to have happen. I believe you should instinctively go short against the box. This buys time to determine what the best course of action is. The problem with being short is that you owe dividends, so you'll need to factor that into your planning.