Examples of Covered calls

Let’s say you hold stock holding in blue chip companies and you would like to get some income besides the dividends amount from the stocks you own and you don’t want to loose that easy .

We don’t use any complicated strategies here but simple and powerful one’s 

Let say we hold 200 shares of coca -cola with $50 striking price and an expiration date in June 2018

If the share price  is above $50, this would be good deal.by exercising the option the call owner could buy some thing for $50 then buying at 52 or $53 in the open market right !!

If the share price is below $50, no incentive in exercising this option.

Instead of buying share at $50, the call owner could simply buy shares for a lower price in the open market.

On the other side , seller is obligated to sell 100 shares at the at agreed up on price.

If the shares of coca cola trading above $50 we limit our profit on upside.

If the share price below $50: the option likely to expire unexercised and you do not have to sell your shares the reason it is called  covered call  is because you already own the underlying security.  But its risky move ?? Why explain ???

Some of the things to strategies

Buy the calls and sell an equal amount of calls against it.

Sell shorter month calls against it.

Choose two different months to sell his calls.

First look at march 17^th position  122.7 price

Sell March 17^th strike $123 for $1.28

Return based on 100 shares = $128/12271 =1.04%

Lets say 1 sell Jan 18 $125 strike call @5.33

533.00

Advantages of covered calls

·        Some of the benefits of covered calls strategy is More income. Upfront cash flow,  Once agreement is made you receive upfront cash flow, and its yours to keep regardless whether option is exercise or not.  This is considered a conservative strategy which will typically make money unless the stock drops dramatically resulting in a potential loss.

·        By selling options against those securities we can increase cash flow of our portfolio and make that asset more productive but, doesn’t want their stock called away.

·        A covered call is held in order to attempt to take advantage of a neutral or declining stock, and in exchange for receiving the call premium, we forgo some upside in the stock. This strategy is beneficial for every investors because it is not only protects the investors downside risk in a flat to doen lmarket but it also provides diversification benefits, produce superior risk adjusted returns and reduce portfolio volatility

·        Keep in mind that selling covered calls adds no risk other than you may, potentially miss a big move up in the stock upside as you have already promised to sell it for "just" (at predetermined price.)

simple criteria’s to find  Best stocks for options

·        Select stocks with strong balance sheets,

·        stocks that has increased dividends pay outs atleast for 5 years

·        Blue chips stocks are my best picks.

Some of my Top resources to find such stocks

·        Morning star research ( pick that Has three to 4 star ratings)

·        Value line research

·        Wall street journal news paper

·        Investor’s business daily

·        Kiplinger’s personal finance 

Covered call is a strategy used to generate synthetic stream of income,

Covered call writing is considered a lower-risk option strategy. You buy the shares of the underlying shares and sell covered call options against those shares. If the stock rises and the calls are exercised, the covered writer simply delivers the shares to the call buyer at the strike price of the call.

Assuming XYZ is at $50 per share, and the XYZ December 55 calls are trading at $2, the covered call writer would buy the shares and write (sell) a December 55 call. At this point, the covered call writer has reduced the cost of holding XYZ by $2 per share. He paid $50 for the shares, less $2 per share in premium income.

The trade makes money in a rising market, in a flat market and because it reduces the cost of the underlying shares, it carries less risk than an outright long position in the underlying stock.

The maximum profit occurs at the strike price of the call. If the stock is above $55 per share at expiration, the call will be exercised, and the covered call writer will deliver the shares at $55 each. Maximum profit is $7 per share; $5 per share, which is the difference between the cost of buying the shares and the strike price of the option, plus $2 per share option premium. Only if the underlying stock rises dramatically between the time the calls are written and the expiration date, is the covered call writer in an inferior position. Maximum risk would occur if the stock were to decline to zero. Mind you that is not a risk factor of the covered

Call option seller or writer: Call option Seller, on the other hand, He is obligated to deliver the underlying stock at the strike price when buyer choose to exercise his call option as well He receives a fee is called as ‘premium’ for taking such risk;

Covered call in simple terms is to sell to somebody else, the right to buy 100 shares you own at a higher price than its current trading price. On the other side, the buyer of a call option is very optimistic as I mentioned that the price of the stock can rise above the seller’s expectation’s stock price.

Outcomes:

If price of the stock fails to increase in its price. the seller of the option or the covered call writer of the option keeps the stock and receives premium or the fee from the buyer from selling the call.

If the stock rise above the seller’s expectation price, up on option exercised by buyer, Seller is obligated to deliver the stocks, means loose the stocks owner but He or she keeps the premium from the selling the call and the profit from selling at the higher price.

Note: Covered call means the seller of the call already own 100 shares in his stock account and maintains an obligation to deliver a stock to an option buyer up on exercise.

What are Options

 What are Options contracts 

Option contracts

Many say Buying  and holding stocks  strategy is the way in building wealth, well, just this strategy doesn’t help you generate income so personally To understand the one and only win option strategy listed in this book. It is very important to understand the basic foundations of option 

Let’s start with an option. What is option.

It’s a choice.

Let me explain with an example

Let say you want to sell your property for $100,000 and I am looking to buy properties for low prices to sell higher prices for profit. So, I am not sure to buy your property, so I pay you $1000 for the option to buy it from you but not obligated for a period of 2 months while seller waiting in closing the sale, contracts protects him against any decrease prices in property for period of 2 months. Meanwhile I keep looking for other properties the Option contracts protects me against any Factors like rise and fall of housing market.  if find no properties that takes my interest, I will exercise my option contract and buy it from you for $100,000 before end of the period, so I paid you in total of $101,000 (includes option fee and for property) your primary responsibility as a Seller is to deliver the assets or property to me up on option exercised. Later I sell the property for profit say $120,000 reaping $20,000. If I hadn’t made the sale, as a seller you would keep $1000 as a fee or premium I paid for you for option contract and I would lose $1000 and let the option expire worthless.  In real world, Option contracts works in similar fashion with Calls and Puts.

Call option: An option that grants the holder the right but not the obligation to buy the underlying at a predetermined price. The buyer of a call is expressing a bullish (optimistic) view of the underlying stock, an increase in price of an underlying stock bring the profit for a call option buyer. The risk of being a call option buyer is with the decrease in underlying stock, chance of losing all the capital invested or the premium paid to the seller.

If X thinks a stock ABC currently trading at price $25 speculates it could reach to $50 with in next 3 months buys an Call option for $200, which means X has a right to buy 100 shares of ABC for $25 any time with in next 3 months but not obligated to. If as speculated stock reach to $50, buyer exercise the option and sells it in the market for $50 for profit of $25 a share. If the stock had not gone up, buyer simply let the option contract expire worthless and his total loss would be the premium paid to the seller ($200) , instead of buying 100 shares and suffer loss in times of decrease of the price in stock, its better off just to buy call option and limit the loss with premiums paid.

What is put Option?

Let say a  stock ABC is currently trading at $80, sudden change in management or due to other market factors you think that the stock is overvalued and will decrease to $65  , Instead of selling it short at $80 with an unlimited risk, you buy a put option at strike price $80 for 1 month for $100 ($1*100 )  per contract , before the expiration of your option the stock breaks to $60 and put trades at $4 .  you can close this position either by selling the put or by exercising it in the open market, If the option trades at $4 (4*100)   my profit in selling the put is $300($400-$100) . If I choose to exercise in open market, I would buy shares for $60 (60*100=$6000) and then put(sell) shares at $80 as I have right to sell with profit of $2000 (($80-60 )*100). Here my Maximum loss of premium $100 would be if stock price increase above $80 and maximum gain is if stock price is below $79 ($80 strike price minus the premium paid)

Why Options?

 They give the holder an unlimited chance for profit with a fixed and limited loss.  Options can be used for various reasons such as to protect a profit, protecting your assets in times of declined market, purchasing call options is much inexpensive than purchasing 100’s of shares thus minimize your initial investments. 

How option protect your stocks portfolio:   Suppose you own 100 shares of  XYZ purchased at  $20 a share now selling price in the market is $25. But you think stock has potential to go much higher later though it has down side for short period of time due to management change or new product launch, nevertheless, he would not lose the profit he has now so you can buy a put  at $25  for 90 days, which will cost him about $200 per put contract , If at the end of 90 days the stock is selling at abandons his put-option contract, and he is free to stock at 10 points additional profit or not, as he sees By having the put, he increased his profit by 10 against a cost of $400 for the 90-day protection. the other hand, the stock had declined to 50 during of the put, he would have delivered his stock at 75 the put options, instead of selling his stock in the at 50. Another useful function of the call option: Consider position of a man who has bought stock at 30 and that it is now selling at 20. He would like to buy an additional stock at 20 to average, but he has neither the age nor the desire to take the financial risk. Instead of buying additional stock, he buys a call at 20, good for 90 days, for which he pays $200 per hundred-share call. He knows that the additional risk in trying to average is limited to the cost of the call. ever, if the stock should advance to 30 in the 90 days the call contract, he can sell 200 shares at 30 - the stock that cost 30 and the hundred that he can through his call at 20. A bad trade turned into profit by a limited risk of $200 for the call option! It might be well to point out that the premiums for put and call options vary according to the price stock in question, the length of the option, and the tility of the stock. Calls on Radio selling at 38 would not cost as much as calls on General Motors selling at 93 not would a 90 -day call cost as much as one for six months ten days. All options that are sold by members of the Put and

The options contract: - 100 shares of stock is referred as 1 contract

 example:  XYZ stock is trading $40/share.

Say                XYZ July 45 call is trading for $1(in premium or a fee )

  For single contract (100 shares of   XYZ )  the cost  would be $100 (1*100=$100) + commissions,

Up on option exercised, The shares can be owned for $45/ share or $4500  

From the examples we see Options contracts have an expiration date, after this date, any outstanding options held and not exercised become worthless. Some 90 percent of options expire worthless.

Strike Price or Exercise Price: It is a Specific price at which underlying stock shares can be purchased or sold, it is a fixed value and is not affected with share price increase or decrease.

Example.

Buy XYZ 1 June 25 Call:

this statement means a buyer  purchase   a  1  call option contract ( 100 shares ) with an  expiration date till June 25^th at STRIKE PRICE or Exercise price $25

 If you want to exercise that Option, You would pay  a share $25 *100  for I contract ( $2500  excluding commissions to buy 100 shares ) any time till the expiration date ( June 25^th)

Sell XYZ 1 June 30 Call

Sell a call option on shares XYZ with the expiration date June  at strike price @30 ;

If Option exercised, the Call Option seller is obligated to deliver or forced to sell the shares at price of $30 even if the stock is trading at $50.

 

Example

Sell XYZ 1 August 29 PUT     

You are willing to sell XYZ  of 100 shares at a predetermined price or strike price at  $29 till the expiration date Aug 29

If this option is exercised, The option seller or writer would have to buy 100 shares of XYZ  from option buyer for $29/share  or $2900 ( commission excluded ) from price 0 –  $29)  with in the expiration date.

Options In the Money (ITM), at-the-money (ATM ), or

Some time

An option can be :

in-the-money ( ITM ), or

at-the-money ( ATM ), or

out-of-the money ( OTM ).

in-the-money ( ITM )

.

For call options, an in-the-money call is one where the stock price is above the call strike, so it has a positive intrinsic value.

Example

At-the-money calls have the same or nearly the same strike price as the stock price,

Example

out-of-the-money calls have a strike price well above the stock price.

Example:

The opposite is true for puts. In-the-money puts have a strike price above the stock price, at-the-money puts are still near the stock price, but out-of-the-money puts have a strike price well below the current stock price.