HI MARK Hello Nirmal,
POT IS VERY EXPENSIVE NOW. TODAY=$198.16 I FEEL THAT IT IS GOUNG UP FOR THE NEXT 1 YEAR. I WANT TO WRITE COVERED CALL FOR INCOME.
SO I AM PLANNING TO DO THE FOLLOWING
-BUY JAN 2009 150 CALL PREMIUM= $66.70
SO 1 CONTRACT WILL COST ME=$6670.00 (IGNORE COMMISSION)
-WRITE MAY 220 CALL; PREMIUM=$5.50
SO INCOME WILL BE =$550.00 Be careful. It's potential income. It's not income until you earn it.
HOPING I WILL NOT GET ASSIGNED AND MAY CALL WILL GO TO ZERO. IF I AM RIGHT,THEN I PLAN TO WRITE ANOTHER CALL FOR I MONTH NEXT MONTH. So far, so good.
But be certain you understand that this investment has considerable risk if the stock plunges. That is probably okay with you
because you expect this stock to move higher. But I must tell you this: most people who believe 'a stock is very expensive right now'
do NOT think the stock is going higher (or else it would be 'cheap' and not 'expensive.')
IF I GET ASSIGNED, I WILL EXERCISE MY LONG CALL No No No. You never want to exercise a call that has lots of time premium
remaining. It's far better to sell your call and buy stock (to cover your assignment). That way you collect all of the remaining time premium in the option. If you exercise, you lose all time premium, and for a Jan 2009 option, that can be a considerable amount.
I.E BUY AT $150.OO AND SELL TO COVER FOR $220. This is not correct. It is ESSENTIAL that you understand this point: You already paid $66.70 and by exercising you would pay an additional $150 per share. Total cost of stock = $216.70.
I WILL HAVE A CAPITAL GAIN OF $400.00( (220-150)*100) Incorrect again. If this worked the way you think it would work, you would have a
capital gain of $7,000. (220-150)*100 is $7,000 and not $400. Alas, it's not as easy as you describe it. Your actual gain would be only
100* (220-216.70), or $330. Of course, if you DO NOT exercise your long call and instead, sell that call and buy stock, your profit will be higher.
KINDLY TELL ME THE PROS AND CONS OF THIS STRATEGY. If you are bullish and willing to accept the downside risk of owning a bullish position, the strategy is fine. But, it does not work the way you believe it does.
Please be certain you understand the points as I have explained them to you and write again if something is not clear.
THANKS You are very welcome.
Mark D. Wolfinger
The Rookie's Guide to Options:
The Beginner's Handbook of Trading Equity Options