Stock Trading Question - Covered Calls

Question

My understanding of covered calls is that if I sell call options for a stock that I own and the price of the stock rises, I would have to sell my shares.

What stops me from putting a limit buy order at the strike price of the options I have sold? Wouldn't this provide me the ability to retain the shares despite having sold the covered calls?

It is almost too good to be true because I take basically no risk (apart from trading costs) and still have my shares if the strike price is reached. Please tell me what am I missing?

Answer 1

Now, what stops me from putting a limit buy order at the strike price of the options I have sold. Wouldn't this provide me the ability to retain the shares while selling options?

If you place a limit buy order at the strike price when the strike price is still much higher than the current stock price, the limit buy order will execute immediately at the stock's ask price. This immediately increases your position in the stock.

If you place a limit buy order at the strike price only when the current stock price reaches the strike price:

1. There is no guarantee that the limit buy order would execute. For example, if the stock price gaps up, the limit order may not execute.

2. The stock price could fall after the limit buy order gets executed. Your exposure to adverse stock price movements would be doubled, since you would be holding twice the initial amount of stock.

Answer 2

I think you could very well do that; however, there are some issues.

1. Fluctuations could cause you to buy, without being exercised. If the price rises some where in the middle of the expiration period, and drop before expiration then you could own double the stock and options that would have expired anyway. Options are seldom exercised prior to expiration and are instead traded. One exception would be to take advantage of a dividend.

2. You would have to have dollars set aside to buy the shares. This might mean having money sit idle or be comfortable with/have the ability to use margin.

The riskless-ness of covered calls comes in one's ability to "not go broke taking a profit". Having money sit idle or a margin call may make writing such calls not worth the effort.