Buying stock to cover a call

I thought about this scenario today, and wanted to ask here since I like BWS's turf, he's a friendly lot. It is a bit off topic of the thread, but still relevant I believe.

(Sorry BWS, not meant to be a hijack).


Assume I have $10,000 in an account.

Let's say I buy a naked call on a stock, XYZ. The stock is priced at $10.

So buying the call, for a strike 1 year out at $20 costs (Because that is what I think the stock will be worth in a year), say, $10.

So I would spend $1000 on the call because it's for 100 shares. That is the premium I would pay.

What happens if at the end of that 1 year out, the stock is now priced at $10,000.

Would I be able to exercise that option to grab the stock and then sell it, or would I need $1,000,000 in the account to do it? Or would a broker allow the instant exercise of the option and then immediate selling of stock, allowing the account to go -$990,000 for a brief bit?
 
You gotta feel bad for the guy that sold the call. Just hope it's not BWS! I think that since occ guarantees the option, you will get the million in stock. Then you can sell if you want. Probably easier to sell the call, but you might have to pay a vig because it's so deep itm.

Overnight said:
I thought about this scenario today, and wanted to ask here since I like BWS's turf, he's a friendly lot. It is a bit off topic of the thread, but still relevant I believe.

(Sorry BWS, not meant to be a hijack).


Assume I have $10,000 in an account.

Let's say I buy a naked call on a stock, XYZ. The stock is priced at $10.

So buying the call, for a strike 1 year out at $20 costs (Because that is what I think the stock will be worth in a year), say, $10.

So I would spend $1000 on the call because it's for 100 shares. That is the premium I would pay.

What happens if at the end of that 1 year out, the stock is now priced at $10,000.

Would I be able to exercise that option to grab the stock and then sell it, or would I need $1,000,000 in the account to do it? Or would a broker allow the instant exercise of the option and then immediate selling of stock, allowing the account to go -$990,000 for a brief bit?
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Overnight said:
I thought about this scenario today, and wanted to ask here since I like BWS's turf, he's a friendly lot. It is a bit off topic of the thread, but still relevant I believe.

(Sorry BWS, not meant to be a hijack).


Assume I have $10,000 in an account.

Let's say I buy a naked call on a stock, XYZ. The stock is priced at $10.

So buying the call, for a strike 1 year out at $20 costs (Because that is what I think the stock will be worth in a year), say, $10.

So I would spend $1000 on the call because it's for 100 shares. That is the premium I would pay.

What happens if at the end of that 1 year out, the stock is now priced at $10,000.

Would I be able to exercise that option to grab the stock and then sell it, or would I need $1,000,000 in the account to do it? Or would a broker allow the instant exercise of the option and then immediate selling of stock, allowing the account to go -$990,000 for a brief bit?
More...
It is a good question because you use extreme numbers to clarify a point. The answer is you bought the shares for $1000. There is no issue. You paid for them with the funds in your account Your account is now worth $1M +10k - minus what you paid for option.
 
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zdreg said:
It is a good question because you use extreme numbers to clarify a point. The answer is you bought the shares for $1000. There is no issue. You paid for them with the funds in your account
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*slaps myself in the head* Yes, of course!!!!

The option is to exercise at $20. So I exercise, buy the shares at $20, and then sell at $10,000!
 
Option_Attack said:
You gotta feel bad for the guy that sold the call. Just hope it's not BWS!
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If it was, that would be where my cheap long calls would come into play: if I was short the 20 call, I'd be long somewhere around 50. Sure, I'll take a loss, and it will sting - but it won't be an account killer.

(For @Overnight: sure, you could call it away from me at $20 when it's at $10k - but I won't be paying that, since I can in turn call it away from whoever sold me that $50 call. I lose $3k minus the premium you paid me but plus the (much smaller) premium I paid for that $50 call; call it $2k all up.)

Learned that much from @Wheezooo... he'd curse you to hell for being a damn fool if you didn't spread off at least some of the risk. Ditto buying cheap puts when you get assigned. That was a man of strong - honestly earned, but strong - opinions. I sure do miss that guy.
 
Just to follow up: AMD kept rallying today, so I spent the last few hours tracking the premium and watching the greeks, then closed the trade when it peaked for a $77 profit. Interestingly, even though I expected the premium to start rolling off below the sold strike (85), the roll-off point came well before I expected it - around 82.75 rather than the 83.50-84 range that the analyzer showed.

Overall, I'm pretty happy with what I got out of this experience: some refinements to my defensive strategy for short puts that go against me (don't roll out the put once you've sold a call, because you end up exposing yourself to more upside risk), and a reinforced sense of doing the right thing for buying a cheap call as insurance. I still wish someone with more experience would add a bit more perspective - perhaps suggestions for other defensive strategies and their pros and cons, or things I could have done better with this one - but hey, it's all good. :)

Thanks to everyone who offered useful suggestions and food for thought!
 
Bekim said:
Why didn't you wait to be assigned the stock before selling a call?
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There are a few reasons:

1) Because the price could drop even further, resulting in reasonable call credit being out of range (unless I wanted to sell below basis - which I certainly don't);
2) Because, in my (admittedly limited) experience, stock prices in large caps usually take "the stairs up but the elevator down" - that is, they rarely rally as quickly as they drop, and usually take a while to come back;
3) Because selling that call during the high volatility right after that big drop gives me enough premium to significantly decrease my basis on that stock and giving me room to make profit on a rally (just as this one did);
4) Because 3 out of 4 scenarios - price dropping even more, staying the same, rising but still staying below my strike, and rising above the strike - have me taking assignment, which turns that call into a covered one;
5) Because, in the case where the price does drop further, I can close that call and capture most of the credit I received for it in just a few days, and hopefully sell another one on a bounce (oh, I forgot to mention that, didn't I... I made another $263 on the previous iteration of that call. This process I've been asking about is just the end phase of this trade; I've been working it since the beginning of this month.)

In the process of writing this out, I've realized that I've been making a mistake - one that specifically goes against point #2: I've been rolling the put out in time under (as I thought of it) the "cover" of that call... and that was the thing that got me into trouble, by extending the period before assignment. I won't be doing that in the future... doing so extends that "vulnerable" period and gives the stock more time to rally! So, yet another useful insight for this strategy.

Thanks for asking this question, @Bekim !
 
BlueWaterSailor said:
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2) Because, in my (admittedly limited) experience, stock prices in large caps usually take "the stairs up but the elevator down" ..
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That is kinda' a lie. I recall your story.

But you pick the shit up quick, and while your experience as a whole may be limited, yer a frickin' sponge. You could be a beginning-level teacher! Yeah, you could do that! Every time I speak with you I feel like I learn shit about options!

See, your brain has not been mired in crap for decades. You waded into this all while you had a fresh brain stem. Meaty cerebellum and stuff.

And your new mentor is prolly going to supercharge your options brain. I envy the options experiences and knowledge coming your way.

 
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