Selling Covered Calls p/l

Question

I recently entered the options trading market to start generating a passive income on stocks I intend to keep for the foreseeable future.

I entered a position on a pharma play with 100 stocks @ $2.70 avg price and decided to sell a covered call with a $0.10 premium (strike price of $3.00). This option was bought, thereby giving me $10.

The price then fell to $2.65, so I thought my total p/l would be 0.05c lost per share (-$5) + premium I received for the call (+$10) making the total +$5. Is this math correct? My brokerage account states that my option has a total return of zero, and I am not sure if this means the premium has somehow been taken away (Do the greeks affect premiums after someone has bought my option?), or if it just means that my option has no intrinsic value (I cannot sell my option to another bidder)... (sorry if this part is confusing, this is where I kind of got lost).

Also would I be correct in stating my total possible p/l is $40 ($10 from option sell, and +$30 if the stock price is at or above $3)?

If this is true, am I right in assuming that as long as I am long on a security, and always have a set exit price in mind, then there is no downside to selling covered calls? It seems like that is too good to be true...and the stock market was not made to win so easily...right?

Thank you

Answer 1

thought my total p/l would be 0.05c lost per share (-$5) + premium I received for the call (+$10) making the total +$5. Is this math correct?

I'm guessing that the call has not expired, but it is now worth less than $0.10 and more then zero, so you'd need to pay some premium to close out the short option leg. Your "gain" on the option would be something less than $10. If the option is now worth $0.05, for example, then your p/l is zero (5c lost on the stock and 5c gained on the option).

Also would I be correct in stating my total possible p/l is $40 ($10 from option sell, and +$30 if the stock price is at or above $3)?

Correct. Your upside is limited but your downside is not. (Technically you maximum loss is $2600 if the stock goes to zero, but the point is that there's no downside protection other then the extreme case.)

If this is true, am I right in assuming that as long as I am long on an option, and always have a set exit price, then there is no downside to selling covered calls?

No, that's not true. Selling a covered call just lowers your "breakeven point" if you hold everything to expiry by the amount of the premium. So your breakeven point for the stock is now $2.60 instead of $2.70. If you sell at $2.60, you will actually lose some since the option will still have time value. Plus you'd need to include whatever transaction costs you incur (both explicit as in commissions and implied as in the bid/ask spread) in your loss. Yes you might be able to exit the position before you get to zero PnL but I wouldn't call that "no downside".

So you are correct in that it is "too good to be true".

Answer 2

The price then fell to $2.65, so I thought my total p/l would be 0.05c lost per share (-$5) + premium I received for the call (+$10) making the total +$5. Is this math correct?

Also would I be correct in stating my total possible p/l is $40 ($10 from option sell, and +$30 if the stock price is at or above $3)?

Correct on both, if at expiration the stock is at $2.65 then the short call expires worthless and your p/l is $5 and if your shares get called away you get the premium and $3/share. If you continue to sell covered calls I suggest tracking your adjusted basis (purchase price less sum of received premiums) in a spreadsheet if your brokerage doesn't track it for you.

If this is true, am I right in assuming that as long as I am long on an option, and always have a set exit price, then there is no downside to selling covered calls? It seems like that is too good to be true...and the stock market was not made to win so easily...right?

I'm not clear on what you mean by being long on an option in the context of covered calls, but there's always a downside/risk. With covered calls you are whittling away at your basis but you're also limiting upside potential.

Answer 3

As per the other answers, for expiration, your calculations are correct.

If this is true, am I right in assuming that as long as I am long on an option, and always have a set exit price, then there is no downside to selling covered calls? It seems like that is too good to be true...and the stock market was not made to win so easily...right?

This is a misstatement. It should say "long the stock" not "long on an option".

In a narrow sense, if you own the stock then there is no option risk when selling a covered call. However, there is opportunity risk in that you give up the upside profit potential above the short call's strike price.

Of greater importance is that the risk lies with the stock. You are risking $2.70 to make a maximum of 40 cents. That's an asymmetric R/R which many traders do nor care for.

Answer 4

Correct, you beat the system.

Kidding, no you'll win in the one condition: when the market stays in a very thin price range for a long time AND people expect it to move heavily in an unknown direction.

Basically, if the market becomes predictable, the premium of the option decreases more and more. If the market is still unpredictable, your calls will be worth a lot more to sell to people, and you earn greater premium.

Covered calls are similar to just buying and holding a stock but with some of the downside lessened. So if that is okay with you then yes you beat the system. You lose a substantial amount of upside, but if all you want is to earn premium like an insurance salesperson, then you've found that business model in the stock market. Covered call traders are not typically beating the S&P500 in the long term, and they also are not earning enough to enjoy the benefits of compounding. But if you just want to support your lifestyle, it is a fairly stable way of doing so. Not great for capital gains.