Premium of Selling in-The-Money Calls It`s All about Monthly Cash Flow
By Saghir Aslam
Rawalpindi, Pakistan
(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)
(Continued from last week)
I like selling the covered call, because one of the advantage of selling an option is that we have a two in three chance of making money, Remember, in the stock market in general, as in each stock in particular, one of three things will happen: the stock will go up, down or sideways.
Let`s explore each of these possibilities with our $28 stock, wherein we write the $25 call option. If the stock goes up, we will definitely get called out at $25 and we have made our profit. We have captured our $4,000 premium of which we have to give back $3000
(remember, we sold the call for $4,$3 of which was in-the-money), thereby leaving a $1,000 profit.
If the stock stays the same, say around the $28 price, we will get called out and our profit will
Be the same $1,000.
If the stock goes down but stays above $25, we will still get called out and make out $1,000 profit .
If the stock goes below $25, we still get to keep the whole $4,000 option premium, and we would determine whether we are on a profit or a loss situation, dependant on what price we paid for the stock.
If we buy a stock, the only way we make money is if it goes up in price. If we buy a put option to protect the downside movement in the stock, the stock must move down for the put option to go up in value, Again a one in three chance of making money, By selling the call we have two in three chance of making money actually, we have a two and-a-half in three chance of making money because the stock could go down a little bit and we still make money.
It is so easy for stocks to spike up and then immediately retrace (pull back from) the last run-up. Writing covered calls gives you a way of selling part of the stock- that which is above the strike price. If that part represents the last run-up in the stock and the part of the profits that is most likely to be lost as the stock retraces itself to a lower level, we will benefit greatly by selling the Call option at the current time, and then if and when the stock backs off, buy back the call option to either sell it gain or to sell the stock.
One of the reasons I like writing covered calls is because it allows you the opportunity to get involved get uninvolved by buying the option back and the get involved again. I have shared that it is more important to make correctable decisions than it is to make correct decisions.
This strategy of writing covered calls lets us say in the game and allows us to keep making
correctable decisions.
BACK TO THE STUDY
The following is a chart of the same stock we used in our 20% Monthly Covered Call Challenge. This time I wrote in-the-money calls. You can see that the numbers speak for themselves. The rates of return are quite substantial , but could even be higher had we written further-out-The-money calls and had all of the stocks risen.
(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.)
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