Deep ITM covered calls

SanMiguel

SanMiguel

Got this little excerpt from a website:
For example, the QQQQ is trading at $29today and its $22 strike price call options are bidding at $7.30 with a delta value of 0.99, which is almost 1. The $22 strike price all options have an extrinsic value of $0.30, which will be the maximum profit for the position should the stock close at any price above the strike price of the short call options, which is $22. Now, in order for this position to lose money, the QQQQ needs to drop below $22, which is a drop of 24%!​

Why do you only make 0.30 on the short call?
Assuming the stock stays at $29 don't you make the immediate $7.30 * 100 on the write?
 
If the stock stays above $29 but you sold a $22 call then how could you make $7?
Anyone who sells a $22 call loses $7/share when the stock goes to $29.
Or if you sell a $29 call on a $29 stock and the stock goes to $36 then you also lose $7.
Anyway, no one would give you $7 of “immediate” profit, so option prices are set appropriately to make sure you don’t make anything immediate and without risk :)
 
It's an ITM option.
The stock is bought at 29, stays at 29.

Another example:
Galactic Holdings Inc.
SPCE 32.58 (-1.46)
Sell 2020 20-MAR 29.0 (23) 6.30 6.50

Here you're making 6.40 for a potential loss of 3.58?
 
Oh, covered calls are identical to naked puts at the same strike. So when you sell the $22 covered call then it’s like selling $22 naked put without having the stock and just getting it assigned later. Your max loss is ~$2200 if the stock drops to $0 in both cases. And the $22 put on such stock should be worth $0.30 - same as the profit from covered call at $22 strike. In both cases you take the risk of losing on the value of the stock. You gain only $0.30 because otherwise everyone would be selling expensive 22-strike puts and making a killing. You can’t make $7 here because if the stock goes down you lose on the stock, while when it goes up you keep the $0.30 profit. The assumption is that it won’t move.

SPCE is more risky and you can get paid a bit more for taking higher risk.
Again, you can sell covered call or naked put at the 29-strike for the same potential profit of ~$300 if the stock goes up, while you can lose up to ~$3200 if the stock goes to zero (though you get to keep $300 profit from selling naked put or covered call, so the max loss would be closer to $2900).
 
qwertyjjj said:
Got this little excerpt from a website:
For example, the QQQQ is trading at $29today and its $22 strike price call options are bidding at $7.30 with a delta value of 0.99, which is almost 1. The $22 strike price all options have an extrinsic value of $0.30, which will be the maximum profit for the position should the stock close at any price above the strike price of the short call options, which is $22. Now, in order for this position to lose money, the QQQQ needs to drop below $22, which is a drop of 24%!​

Why do you only make 0.30 on the short call?
Assuming the stock stays at $29 don't you make the immediate $7.30 * 100 on the write?
More...


  • QQQQ?
  • $29?

Your article is from 2003
 
So it's the difference between the current stock price and the strike that needs to be less than the premium?

Something seems odd since the breakeven on the spce would be 26.
You still keep the initial premium, you just have to give your stock when it's called away...
 
qwertyjjj said:
It's an ITM option.
Galactic Holdings Inc.
SPCE 32.58 (-1.46)
Sell 2020 20-MAR 29.0 (23) 6.30 6.50

Here you're making 6.40 for a potential loss of 3.58?
More...

Way off: what if the stock goes to $20? To $10.87? To $0.00? What happens to your covered call investment, for each dollar it falls below [$32.58 - $6.40 = ] $26.18? Uh-ohhhhh. :confused: [stock purchase - call premium]

Returning to QQQQ example, the website is wrong w/r/t a loss starting at any price below $22.00: it's $21.70 [stock purchase - call premium] -- a detail significant well beyond 30¢.

If you want to understand these things, go for the algebra first, then plug in examples to provide, y'know.... examples.

[EDIT] Re-read Guru's responses -- lots of good stuff there. :thumbsup::thumbsup::thumbsup:
 
Last edited:
Ok, example
SPCE:
400 shares at 22.40
Sell 4 calls 16 strike @ 7.11
Net debit = 8960 - 2844 = 6116
If stock above 16 at expiration, you receive 400 x 16 = 6400

Profit = 284
3.1%
You make a profit as long as stock is above 16 on expiration.
Stop loss needs to be around there or put a protective put on if it drops.
 
qwertyjjj said:
Ok, example
SPCE:
400 shares at 22.40
Sell 4 calls 16 strike @ 7.11
Net debit = 8960 - 2844 = 6116
If stock above 16 at expiration, you receive 400 x 16 = 6400

Profit = 284
3.1%
You make a profit as long as stock is above 16 on expiration.
Stop loss needs to be around there or put a protective put on if it drops.
More...

Is this Jeopardy? Do we have to respond in the form of a question?

Okay, I'll play: "Alex, what is a 71¢ max profit on a $22.40 purchase and a $7.11 call premium?"

The rest of the numbers are irrelevant and will distract you. The only things that matter are the current price of the underlying, against the price (premium) received of the call option, and the difference between the underlying and the call's strike.

Do yourself a favor and stop now, and work these out on your own.
 
qwertyjjj said:
Profit = 284
3.1%
You make a profit as long as stock is above 16 on expiration.
Stop loss needs to be around there or put a protective put on if it drops.
More...

Profit and ROI are correct but breakeven is 15.29
Selling .71 premium. (16 -.71 = 15.29)

If stock closes below 16 at expiration you'll still hold onto your stock but will have profit at any price above 15.29.
 
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