Premium of Selling in-The-Money Calls
It`s All About Monthly Cash Flow
By Saghir Aslam
(The following information is provided solely to educate the Muslim community about investing and financial planning. It is hoped that the Ummah will benefit from this effort through greater financial empowerment, enabling the community to live in security and dignity and fulfill their religious and moral obligations towards charitable activities)
For example: if the stock is at $28, but is at a near-term high-point, we could sell the $25
Call for around $4. Then, if the stock backs off to $26, we could buy back the $25 call for around $2 If we did ten contracts we would have generated $4,000 into the account, and would now be spending $2,000 to buy back the option, thereby netting the other $2,000.
Now, as the stock rises to $27 of $28, we could either sell the $25 call or the $35 call a week or two later. On the next dip, we could buy back that call and sell it again on the next rise.
This could go on ad infinitum. The stocks take two to three weeks to roll up and down, so it probably could not be done numerous times within one month. But it is not uncommon to
have the opportunity to do this two to three times in one month. This would be a nice cash flow generation machine.
Even on doing this strategy, you would still ask the same question – “Do I want to get called out of the stock?”- Each time you sell a covered call. Your option could change, even in a one- or two-week period of time.
Recently, I performed a study on trying to generate a 20% monthly return. In that study I sold slightly out-of-the-money calls. We also took the assumption that we were stocks rose in value
To the strike price and we were called out to generate the 20% monthly premium. If we did not get called out of these stocks, we simply still owned the stock and could write covered calls again and again.
Now, however, as a follow-up to that study I change the strategy slightly, but you`ll soon see that there were dramatically different results. This time, we wrote slightly in the money calls, but took the assumption that we was called out. There is an unusual phenomenon in doing
this, which should explore before we show you the results of this study. This phenomenon will generate a new world or two for you-jargon in the stock market.
The term is,”give back.” Let`s explore what this means. If we own the $28 stock and sell the
$25 call for $4, you can see we are writing an in-the-money call of the $4 option premium, $3 of the option. Another way of looking at this is that $3 of the option premium is actually part of the stock price. If the stock is at $28 and we write the $25 call, the stock is $3 above for strike price . If I sell the call for $4 and if we are to get called out at $25, then out of that $4, I have to “give back” $3.
(To be continued)
(Saghir A. Aslam only explains strategies and formulas that he has been using. He is merely providing information, and NO ADVICE is given. Mr Aslam does not endorse or recommend any broker, brokerage firm, or any investment at all, nor does he suggest that anyone will earn a profit when or if they purchase stocks, bonds or any other investments. All stocks or investment vehicles mentioned are for illustrative purposes only. Mr Aslam is not an attorney, accountant, real estate broker, stockbroker, investment advisor, or certified financial planner. Mr Aslam does not have anything for sale.)