1

when writing covered calls and the stock value decreases. Sure your calls decrease to $0 and expire worthless (the desired scenario) but your stock position can continue taking a greater loss.

so consider this scenario: You bought 100 shares at $50, and sold 1 at the money call at strike $50

Stock price decreases to $43 , call will expire worthless but it may not be expiration day, so thats great.

Write new covered call at the money at $43 (same expiration date or next expiration date out)

Stock price increases to $45 and you get assigned.

Since you delivered shares at $50, which were taking a loss and delivered shares at $43 while the stock was still at a loss from the entry position

is this a loss or does the time premium collected continue to make up for this scenario? I'm having trouble calculating this series

can I deliver shares at that assigned strike using margin or additional capital if I have it? Can the broker just take care of it and let me collect the time premium? Not sure what happens here, never been assigned.

  • 1
    Ok. I'll comment on edits here, so I can remove as you edit. - "Since you delivered shares at $50" - You mean 'you bought', right? I think I understand the intent of the question, but there's not one answer as it's phrased. If the options premiums were $7 or greater you have a gain. If less, loss. – JoeTaxpayer Dec 4 '11 at 15:51
  • @Victor123 Victor, you already know you are supposed to be asking new questions, not commenting on old questions – CQM Oct 14 '14 at 19:23
  • Ok i deleted it... – Victor123 Oct 14 '14 at 19:51
  • To calculate profit and loss, you need to provide the premium you are collecting for selling options. Also if stock drops to 43, the call written at 50 may not automatically go to zero. If it is far out in time, the high negative vega may stop it from going to 0. When stock drops to 43, the IV will explode. And this will increase the value of the call even if it is out of money. Of course, at expiry, the call will be worthless, but before expiry, it may not be. – Victor123 Feb 28 '15 at 16:54
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It's unclear what you're asking. When I originally read your question, it seemed that you had closed out one options position and opened another. When I read your question the second time, it seemed that you were writing a second option while the first was still open.

In the second case, you have one covered and one naked position. The covered call will expire worthless, the naked call will expire in the money. How your broker will resolve that is a question best left for them, but my expectation is that they will assign the non-worthless calls. Whereas, if both options expired in the money, you would be assigned and you would have to come up with the additional shares (and again, that depends on how your broker works).

In general, for both cases, your net is the premiums you received, plus the difference between strike price and the price that you paid for the stock, minus any cost to close out the position. So whether you make a profit is very much dependent on how much you received for your premiums.

Scenario #1: close first call, write second:

- 5000 = Original stock price: $50
+  200 = Received premium of $2 for ATM C50
-   25 = Paid premium of $0.25 to close C50
+  400 = Received premium of $4 for C40 when stock is at 43
+ 4000 = Received when options are assigned
-    ? = Commissions on 5 trades

Scenario #2: write covered + naked, one expires worthless

- 5000 = Original stock price: $50
+  200 = Received premium of $2 for ATM C50
+  400 = Received premium of $4 for C40 when stock is at 43
+ 4000 = Received when options are assigned
-    ? = Commissions on 4 trades

Scenario #3: write covered + naked, both expire in the money

- 5000 = Original stock price: $50
+  200 = Received premium of $2 for ATM C50
+  400 = Received premium of $4 for C40 when stock is at 43
+ 5000 = Received for C50 when options are assigned
+ 4000 = Received for C40 when options are assigned
- 5500 = Paid for stock to cover naked options; stock is now at $55
-    ? = Commissions on 6 trades
-    ? = Margin interest if you don't have cash/stock to cover C40

Disclaimer: the SEC does not consider me a financial/investment advisor, so this is not financial/investment advice

  • Why are the calls priced far higher when the stock is $43? Aside from that, your scenarios look good. The first is what OP appears to be doing. One option open at a time. – JoeTaxpayer Dec 4 '11 at 17:55
  • @Joe - sloppiness on my part. I remembered the OP talking about "at the money" calls when the stock was 43, and of course that didn't make sense, so I picked a number that did -- just the wrong way. Editing to make the strike price 40. – kdgregory Dec 4 '11 at 22:01
  • Got it. The op loses $375 in first scenario, vs $700 he'd be out on just owning the stock. – JoeTaxpayer Dec 5 '11 at 0:29
  • @Joe - true, but the $700 is a paper loss, the $375 is real. – kdgregory Dec 8 '11 at 20:48
  • I am a "mark to market" guy. I understand the distinction you make, but don't believe it to change anything in the example. – JoeTaxpayer Dec 8 '11 at 21:22
4

If your shares get called on stock at a price below what you paid for the stock, your gain or loss depends on what premium you got for the options you sold.

"can I deliver shares at that assigned strike using margin or additional capital if I have it? Can the broker just take care of it and let me collect the time premium? "

You don't need margin or any cash because you already hold the shares. A covered call means your cash requirements are 'covered'. So they'll just buy your shares at the strike price of $50. And you still get to keep the premium (which you should have gotten when you sold the covered call).

You only need cash or margin when you've sold an uncovered call or put.

  • this is the conclusion I've come to as well, I'll paper trade it on both FAS and FAZ, because one of them will decrease in value since they are opposites. – CQM Dec 4 '11 at 22:16
1

An expired option is a stand-alone event, sold at $X, with a bought at $0 on the expiration date.

The way you phrased the question is ambiguous, as 'decrease toward zero' is not quite the same as expiring worthless, you'd need to buy it at the near-zero price to then sell another covered call at a lower strike.

Edit - If you entered the covered call sale properly, you find that an in-the-money option results in a sale of the shares at expiration. When entered incorrectly, there are two possibilities, the broker buys the option back at the market close, or you wake up Sunday morning (the options 'paperwork' clears on Saturday after expiration) finding yourself owning a short position, right next to the long. A call, and perhaps a fee, are required to zero it out. As you describe it, there are still two transactions to report, the option at $50 strike that you bought and sold, the other a stock transaction that has a sale price of the strike plus option premium collected.

  • I'll rephrase.the sold option moves further OTM,now nearly worth zero, yes it will need to be bought to open a new one.We are going to roll down and write another call near the money. The stock position is now taking a noticeable loss (ex. bought shares at $50, now trading at $40), but the main goal is to continue collecting premiums from the writing. If the stock rises again, our new $40 short call is now ITM by expiration (the stock closes at $45 on expiration day) and we get assigned. is this a loss? we have the premium from the $40 write, but we deliver shares from the $50 stock purchase. – CQM Dec 4 '11 at 5:27
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I don't think you understand options. If it expires, you can't write a new call for the same expiration date as it expired that day.

Also what if the stock price decreases further to $40 or even more?

If you think the stock will move in either way greatly, and you wish to be profit from it, look into straddles.

  • Replace "expires worthless" with "decreases toward zero". At this point it will expire worthless but not necessarily has yet. In the same option series there will be new near the money option with value left in it worth writing. Unfortunately with straddles, the time decay predicting such a move can eat away profit potential. I'm not here to discuss other option strategies, can you comment on the question I asked? – CQM Dec 4 '11 at 3:50

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