6

In this trade, I write an in-the-money covered call and buy an in-the-money put (as an example) on GM, expiring in September 2014. The call premium is $10.02 with a strike of $26, and the put premium is $4.17 for a strike of $37. GM's share price is $35.10, and I plan to write 1 call and buy 1 put.

My commissions are $7.95 per trade and $0.75 per contract. Here are the legs of the trade as I calculate them:

  1. I buy 100 shares at $35.10, which costs

    -(100 * 35.10 + 7.95) = -$3,517.95
    
  2. I buy one put contract ($37 strike) at $4.17, which costs

    -(100 * 4.17 + 7.95 + 0.75) = -$425.70
    
  3. and I write a call option ($26 strike), which earns me the premium minus costs (I don't pay a separate 7.95 commission because I already paid it when I bought the shares, per my broker's policy)

    100 * 10.02 - 0.75 = $1,001.25
    

The total cost of the trade is therefore

    -$3,517.95 + -$425.70 + $1,001.25 = -$2,942.40

Assuming I sell the shares immediately at expiration if the covered call isn't assigned (which I may or may not do), here's the profit/loss I calculate for four levels of the share price at expiration (or at any point in time when the call option is assigned):

  1. Share price: $20 (below the strike of the covered call). I exercise the put:

    100 * (37 - 20) - 7.95 - 0.75 = $1,691.30
    

    keep the premium from the call option ($1,001.25), and liquidate my shares immediately

    100 * 20 - 7.95 = $1,992.05
    

    this gives me profit of of

    1,691.30 + 1,992.05 + 1,001.25 - 2,942.40 = $1,742.20 
    
  2. Share price: $30 (above call's strike price, below current share price and put strike). Exercise put:

    100 * (37 - 30) - 7.95 - 0.75 = $691.30
    

    keep call premium, and sell shares when call is assigned:

    100 * 26 = $2600
    

    for profit of

    691.30 + 2600 + 1001.25 - 2942.40 = $1350.15
    
  3. Share price: $35.10 (unchanged). Exercise put:

    100 * (37 - 35.10) - 7.95 - 0.75 = $181.3
    

    keep call premium, and sell shares when call is assigned:

    100 * 26 = $2600
    

    for profit of

    181.3 + 2600 + 1001.25 - 2942.40 = $840.15
    
  4. Share price: $40 (above call and put strike prices). Put expires worthless, keep call premium, and sell shares when call is assigned:

    100 * 26 = $2600
    

    for profit of

    2600 + 1001.25 - 2942.40 = $658.85
    

Is this math correct? What risks do I run with this strategy?

  • @JoeTaxpayer Thanks for the edit. that makes it simpler to follow the math, you're right. All the math is pretty simple but it seemed weird that there was no way to lose money, and my minimum gain ($658.85) given the initial investment of $2,942.40 is about 22% which is awfully high for such a low-risk trade (if I understand the risks properly) – Michael A Mar 19 '14 at 17:35
  • 1
    Note that the call is probably a deep in the money option, so I suspect this would create a straddle for tax purposes under §1092. That could suspend your holding period and render dividends non-qualified, as well as placing limitations on your ability to take a tax loss. – NL7 Apr 18 '14 at 15:16
  • Yes, correct. You had me fooled too, adding the call premium once at the time of opening the trade and then again at the time of liquidating. – Victor123 Oct 14 '14 at 18:55
  • No, the math is not correct. Ignoring the commissions, the BE point is $33.75 with a maximum gain of $775 and a maximum loss of $325. Your trade is a "guts" long stock collar which is equivalent to a bearish vertical spread and would be better placed as a vertical since it involves less B/A slippage and fewer commissions. Also, by selling the deep ITM call, you run the risk of early assignment. The quick calculation of P&L for your numbers is (put strike*100 - $2,942,40) versus (call strike*100 - $2,942.40). – Bob Baerker Jan 30 at 0:27
6

You own the stock at $29.42

At $40, the stocks is called at $26. You can't add the call premium, as it's already accounted for. The trade is biased towards being bearish on the stock. (I edited and added the graph the evening I answered)

enter image description here

Not the pretiest graph, but you get the idea. With that $29.42 cost, you are in the money till about $30, then go negative until the most you lose is $3.42.

  • 10
    Hardly. I know idiots. Instead of asking first, they'd trade and with a successful stock move, find they lost money. You thought it too good to be true and asked the question. The idiot doesn't ask. – JoeTaxpayer Mar 19 '14 at 17:58
  • The stock is in-the-money at any price since it will always be above the call strike or below the put strike or both. Ignoring all of the commissions, the break even is $33.75 and the position goes negative above that price. – Bob Baerker Jan 30 at 0:41
2

FYI: GM has an earnings announcement on April 24th.

I think you were trying to create a safe trade by profiting if GM's price fell within a probable range. The chart of the Iron Condor captures just about a standard deviation of movement. So as long as GM is between 31.28 - 37.22 in 34 days you keep the max profit of $110. Note this trade is a net credit, when placing it you get $110 less fees.

Iron Condor 1 std

Also by selling the deep in the money call I take it you were trying to make the most of your capital.

The chart below shows a standard covered call compared to short put vertical. Note the short put vertical simulates the covered call position and it is a net credit trade as well. When you drop the order you get $111 less fees.

CC vs Short Put Vertical

  • 1
    what platform is this? My platform's graphs are dreary, these are pretty! – CQM Apr 19 '14 at 17:04
  • Dough - the visual options trading platform. Their website makes use of TD Ameritrade's API. If you have a TD Ameritrade account you can trade with dough. – emican May 12 '14 at 3:18

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.