Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Pastimes : The Justa & Lars Honors Bob Brinker Investment Club -- Ignore unavailable to you. Want to Upgrade?

To: Thomas M. Carroll who wrote (1829)	10/26/1998 12:55:00 PM
From: DD™	Respond to of 15132

Covered Call You, as the shareholder, write (sell) a call option on the shares that you own. You do this if you expect little upward price movement in your stock, such that the call option expires worthless to the buyer. You collect the option premium as profit. DD

To: Thomas M. Carroll who wrote (1829)	10/27/1998 12:24:00 AM
From: Trebor	Read Replies (1) \| Respond to of 15132

>Would you have the patience to explain briefly what a "covered call" is ??? Thanks< A covered call is a contract to sell a stock at a certain price (the strike price) on or before a specified date (the option expiration date). "Covered" simply means you own the stock, as opposed to a naked call where you don't own the stock. Calls are normally priced at $2.50 increments, thus, on a $20 stock, you could sell a call at strike prices of $20, $22.50, $25, $27.50 and so on. One contract represents 100 shares. When you sell a covered call, you collect a premium up front for doing so -- this is cash you keep regardless of what happens next. The farther out the call time-wise, the higher the premium, thus a January call will be worth more than a Dec. call because essentially you are selling the time value of the call, which deteriorates as the call gets closer to expiration. Call options expire the 3rd Friday of the month they are written for, thus Oct. options expired Oct. 16, Nov. options will expire Nov. 20, etc. If a stock does not reach the strike price by the expiration date it expires worthless, you keep the premium you collected and you still own the stock. If the stock exceeds the strike price by the expiration date, your stock will be "called" away UNLESS you chose to buy back your call, which you can do at any time prior to the expiration date. This last point is an important one, I think, because many people think that once you've sold a covered call you've committed to selling your stock. Ain't so. Here is an example of how it might work: Suppose today you bought 1000 shares of UTEK at $18/sh. You could now sell 10 UTEK February $20 covered call contracts at right around $2/sh or $200 for a contract. Thus you would take in $2,000 in premiums, bringing your cost basis down from $18/sh to $16/sh. If UTEK does not reach $20/sh by the third Friday in February, the contracts expire worthless, you keep the $2,000 and you still own the stock. If UTEK exceeds $20 by the Feb. expiration date, your stock will be called away at $20/sh. However, you will have made a 22% return, not bad for a 3.5 month investment. But suppose UTEK reaches $21 by mid-February and you really don't want to sell the stock. You can then buy back your calls probably for around $1 (as opposed to the $2 you sold them for) because there isn't any time value left. You've still reduced your cost basis and you still own the stock. My rule of thumb is if I can buy back a call for less than 50% of what I sold it for, and if I still like the stock, I do so. Now suppose UTEK is $40 by mid-Feb. In that case, you would have been better off not to have sold the calls. That's the risk you take - a lost opportunity risk - and really it's the only risk you take with covered calls. I use covered calls when I have a neutral or slightly bearish short term view of a stock or when I feel a stock has gotten ahead of itself and is due for a correction. On this recent market correction for example, I had a lot of Oct. covered calls expire worthless and that took much of the sting out of the correction for me. I also use covered calls to simply generate cash in my IRA for other investments. Because covered calls are more or less risk free, they are one of the few option plays permitted in IRA accounts. Hope this is helpful. I didn't mean to write a book but I do get enthused on this topic. A good web site for more information is: cboe.com p.s. for simplicity sake I didn't include commissions in the above examples. Schwab charges $30 to $50 for trading up to 10 contracts, based upon some arcane formula I've never understood.