Wednesday, October 6, 2010

Sometimes even when we dont want to we have to let go

The great thing about selling covered calls is that you know ahead of time, in the event that the stock price goes beyond the strike price you sold it at, how much you will make.  Unfortunately your earnings potential is capped at the strike price, but at least you get to decide what that strike will be.  If you set your strike price above the money not only do you get to pocket the premium but you also get the difference between your cost basis on the stock and the stock price.

I purchased AMSC (an alt energy company that deals w/ wind technology) for about $28 a share in july.  I sold a covered call with an expiration of October 15 at a strike price of 36.  I made $70 off of selling the covered call, which computes to an annual return of 7.5% on the premium alone.  Should the stock make it above $36 and be called away from me, I'd make $36 - 28 + .70 = $8.7 per share, or a 31% return on the 4-month trade, which is a 93% annualized return.  I don't know about you but as far as I'm concerned the stock could go up to $50 in the next week (i'd still only profit up to $36) and either way I'll be happy with my 93% annualized return on my trade.

I guess the moral of the story is that you need to make sure that when you initially are deciding on selling a covered call, you will be happy whether or not your shares get called away.  You can't get too greedy with trying to get the highest premium WHILE hoping your shares don't get called away from you.  Decide on a strike price you are comfortable with in the event you do get called away.

I'll keep you updated on whether or not my shares actually get called away.  They are currently at $35...only $1 away and have over a week to get to the $36 strike price.

9 comments:

  1. Your posts are long and confusing, but I love you anyway.

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  2. That's why the comment section is here...so people can ask questions :)

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  3. Okay then, what the hell are you talking about?!?!
    :D

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  4. I'm talking about a covered call position I sold in early July. Basically I own shares of a stock & i sold the RIGHT (but not the obligation) to buy those shares from me to someone.

    They have the RIGHT to buy them for $36 a share (when i initially sold them the shares were only $28 a share), so basically no matter what happens I either:

    a) pocket the premium & upon expiration later this month should the stock price not be equal to or exceed $36 per share. (this would also allow me to sell a new call option to someone else at any strike price and expiration date I wish)

    b) pocket the premium & upon expiration if the stock is selling for above $36, my shares will be called away from me (basically they have to give me $36 for every share, even if the current market value of each share is $50, so in that case i'd be missing out on potential gains of $14 per share (36 + 14 = 50) but at the same time I already picked a strike price that i'm comfortable with.

    does that help clear things up? :)

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  5. Good luck with this. I don't quite understand what it all means, but as long as you do xD

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  6. haha well read up & if things dont make sense then ask questions...you'll learn a lot!

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  7. You've made some interesting points... I also have some points (actually bubbles) on Enhanced by MS Paint :)

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  8. I have to agree with you here. Check out my other TS blog, Swift Fanatics!

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