Can some one please explain how call options, using shares you already own, work?

Please describe the steps involved, and the costs, using an example.

The strategy you are refering to is called writing covered calls. Basically, you write (sell) an option on a stock that you own. One options contract represents 100 shares. If you owned 500 shares of a stock, you could wirte 5 contracts. It is a way to generate income from stocks that aren’t moving. The problem with this strategy is that you limit your upside potential. Stocks rarely move up in a straight line. They typically stagnate for long periods of time, with periodic spikes. With covered calls, you run the risk of missing the upside spikes (the upside potential was the reason you bought the stock to begin with).

The strategy work like this: Say I own 500 shares of AIG. AIG’s stock price is currently $64. I don’t think that we will get much movement for the rest of the month (options expire at the end of business on the third Friday on the month of the contract). I decide to write (5) Sept. 06, 65 calls for $.15 / contract. $75 ($.15 x 500) will be deposited in my account (minus commisions) from the sell of the options. If AIG’s stock price ends below $65, I keep the proceeds and the stock. If the stock price ends the month above $65, the options will be excersized, and I will receive $65 / share for the stock (plus the options premium which is already in my account). Let’s say AIG ends at $70 a month. Even though you are receiving an extra $1 / share above the stock price at the time you wrote the contract, you have missed out on $5 / share for a lousy $.15 premium.

I don’t think covered call writing is a good strategy for most investors, because of the risk of missing out on great returns.

Call Option

Comments are closed