Calculating profits on a covered call. What method do you use?

Question

Hey guys. I was having a discussion with someone about calculating profits on covered calls and I thought I'd ask the community's advice on which way is correct.

I buy....

- 100 shares of XYZ at $7.75 a share ($775.00 invested)
- I then sell a call at the $8.00 strike for a premium of .50 (Collect $50.00)
- The offset now brings my cost per share down to $7.25 a share.
- The person who bought the call won't call me away until the stock reaches $8.50 (He already paid .50 already so it's not worth his while to call me away right at $8.00)
- XYZ Stock reaches $8.50 a share (YAY!)

My question is this.. is my profit the difference between...

$7.25 and $8.50

  OR

$7.25 and $8.00 ?

The only reason I ask is because it seems that counting the .50 premium in the offset and then in the $8.50 might be double dipping.

How do you calculate profits on a covered call? Janie

(Contrary to the warning above I don't think this is a subjective question. Others probably want to know this)

Answer 1

yes, you are double counting. Your profit is between ($7.25 and $8) OR ($7.75 and $8.50).

in other words, you bought the stock at $7.75 and sold at $8.00 and made $0.50 on top.

Profit = $8.00-$7.75+$0.50

(of course all this assumes that the stock is at or above $8.00 when the option expires. If it's below, then your profit = market price - $7.75 + $0.50

by the way the statement won't call me away until the stock reaches $8.50 is wrong. They already paid $0.50 for the right to buy the stock at $8.00. If the stock is $8.01 on the day of expiration your options will be executed(automatically i believe).

Answer 2

assuming call is exercised at 8.50, total profit is $120.00:

• paid: -775.00 (7.75*100 shares)
• collected: 50.00 (.50*10 calls)

at $8.50:

• will collect: 765.00 (8.50*90)
• will collect: 80.00 (8.00*10)
• will pay*: -77.50 (7.75*10)

total profit = $120.00

• total collected: 895.00
• total paid: -775.00

*basis of stock, not paid in cash, so not included in "total paid"

if you hadn't sold the calls, profit would be $75.00:

• paid: -775.00 (7.75*100)

at $8.50:

• will collect: 850.00 (8.50*100)

total profit = $75.00

• total collected: 850.00
• total paid: -775.00