covered calls questions

[hhj]

Will someone please explain covered calls to me? I own shares of Conoco Phillips (COP). I do not understand all the terminology. I want to get money by agreeing to sell the stocks if they reach a certain price ($75) by August 11th. I think I will get $1.39 a share to do that.

So far is that right?

What is the terminology for what I want to do? "Sell covered call options" is what I think.

I think what happens is that if COP goes above $75 a share I have to sell them at $75. If they stay below $75 a share I dont. Is this right?

Is the date that matters Aug 11 or is it anytime before that that I can be made to sell?

Can someone explain the profits if I have to sell at $75? I think it would be $7.50 a share ( the difference between $75 and $67.5 todays price) Plus I would get $1.39 a share plus any dividends between now and when/if I had to sell.

Is that right?

Thanks for any help.

 

[Martinghoul]

http://www.theoptionsguide.com/covered-call-writing.aspx

 

[enni82]

If you sell the Aug 20 2011 75 COP covered call you will receive a fee from the buyer of the option, called a premium. The sale of the call obligates you to sell 100 COP shares at the strike price of $75 by the expiration date of August 20st 2011, regardless of how high the stock price climbs. If the price goes over $75/share the call will be considered "in the money" and you can be assigned to sell the stock at anytime. Assignment is random and if assigned your broker will take your shares and deposit the cash into your account. If COP never reaches $75 it is considered "out of the money" and you can't be assigned to sell. After Aug 21 the contract will expire worthless and you keep your shares and the premium and any dividends. But remember that if COP tanks in the next few months you will be stuck holding the shares.

See the posts in my signature for a few examples.

 

[hhj]

If the price goes over $75/share the call will be considered "in the money" and you can be assigned to sell the stock at anytime.
See the posts in my signature for a few examples.

That is a part that I dont understand. Does the stock get sold or does the guy just sell the option, before the end date? If the price of the share goes to $80 a month before the option expires could I be made to sell the stock? It seems more likely that someone else would buy the option.

Thanks for the help.

 

[Martinghoul]

That is a part that I dont understand. Does the stock get sold or does the guy just sell the option, before the end date? If the price of the share goes to $80 a month before the option expires could I be made to sell the stock? It seems more likely that someone else would buy the option.

Thanks for the help.

What happens before the end date doesn't matter to you. You're extremely unlikely to get assigned before expiry, so don't worry about being forced to sell.

 

[DashRiprock]

what happens if you sell an option and it finishes against you but for whatever reason nonone exercises it?

because like exercising it isnt as good as selling it back to the market... so if you sold one it could be that if you dont buy it back even though its gone against you that noone exercises against you?

i mean it could happen right?

 

[Martinghoul]

If you're short an option that expires ITM and doesn't get exercised, it's either free money or a timing issue (may happen in cases where you expire quite close to the strike, so shouldn't count). In my career I have only once been a recipient of free money. The miracle occurred due to a clerical error on behalf of a particularly anal French institution. Ironic, innit?

 

[DashRiprock]

ok

but if all the people that own the option sknow that its better to sell them than exercise them, who does the exercising for the forgetful ones?

 

[Martinghoul]

ok
but if all the people that own the option sknow that its better to sell them than exercise them, who does the exercising for the forgetful ones?

Not sure what you mean... For pretty much any option that's worth exercising it either doesn't matter whether you exercise or sell the option (reasonably ITM options) or it's actually more optimal to exercise (if you're "pinned"). This holds for most common options where the underlying is reasonably liquid.

 

[DashRiprock]

ummm

example i sell an option and it goes against me and is well ITM. whoever is long my option probably wants tosell it cos its easier... but if i dont make an order to buy my option back i go into expity or whatever short my ITM oiption.

What if someone forgets to buy back or exercise?I have a chance right?

 

[Martinghoul]

ummm

example i sell an option and it goes against me and is well ITM. whoever is long my option probably wants tosell it cos its easier... but if i dont make an order to buy my option back i go into expity or whatever short my ITM oiption.

What if someone forgets to buy back or exercise?I have a chance right?

Firstly, if I am the guy who's long your ITM option, I would prefer to hold it to expiry and exercise it, rather than sell it, which is most likely to be costlier. If expiry comes and I don't exercise this ITM option, I will be giving you money, plain and simple. It will be charity/gift, whatever you call it. Do you think this is likely? Moreover, exchanges most commonly exercise ITM options automatically, so you can't just forget. In order to not exercise (or, if you're long, to exercise sub-optimally), you need to call your broker and explicitly instruct them to do this. So, yes, there's a chance, but it's vanishingly small. As I mentioned, it's only ever happened to me once.

 

[DashRiprock]

Firstly, if I am the guy who's long your ITM option, I would prefer to hold it to expiry and exercise it, rather than sell it, which is most likely to be costlier.

ok yes everything else you said is what i thought... it is not impossible but the exchange or broker does it automatically (so this must be in like contract specifications for options and give up agreements with brokers?)

but what you said above... why would you prefer to exercise against me? isnt it easier to sell your options and buy the stocks from the market?

i suppose it depends on how many options you bought so that its it cheaper from tca to exercise than to buy?

or do you just not like me?

i dont get it.

 

[Martinghoul]

but what you said above... why would you prefer to exercise against me? isnt it easier to sell your options and buy the stocks from the market?

i suppose it depends on how many options you bought so that its it cheaper from tca to exercise than to buy?

or do you just not like me?

i dont get it.

In most cases, the closer we get to expiry, the easier it is to delta-hedge/exercise rather than sell the option. It's not about who the broker is, but rather just a function of what liquidity is like in the options mkt relative to the underlying.

 

[DashRiprock]

ok thanks

 

[hhj]

thank you for the help.