Help me understand what happens here: writing covered ITM calls?

Quote from 1a2b3cppp:

Wait, how do I lose money if price goes below the strike.

If price goes below the 120 strike price then the owner of the call has the right to buy the shares at 120, but why would he want to? They're cheaper at market price.

How do I lose money in that situation? Wouldn't I just keep the shares then since the person who bought the call doesn't want to buy them for 120?
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You're talking about selling a call, right?

So, if SPY falls to say $80, you paid almost $12,000 for a position now worth $8,000. So, yes, you keep the shares, but they are worth a lot less then your total expense was. Of course, it may not be a realized loss until you actually sold the shares.

JJacksET4
 
Quote from JJacksET4:

You're talking about selling a call, right?

So, if SPY falls to say $80, you paid almost $12,000 for a position now worth $8,000. So, yes, you keep the shares, but they are worth a lot less then your total expense was. Of course, it may not be a realized loss until you actually sold the shares.

JJacksET4
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Oh. When I saw the risk/reward graph for a covered call, it showed potentially unlimited losses, so I thought I was missing something.

But how is it unlimited? You've got the cost of the premium + what you paid for the stock. Even if the stock goes to zero, that's not unlimited.

So what am I missing?
 
Quote from 1a2b3cppp:

Oh. When I saw the risk/reward graph for a covered call, it showed potentially unlimited losses, so I thought I was missing something.

But how is it unlimited? You've got the cost of the premium + what you paid for the stock. Even if the stock goes to zero, that's not unlimited.

So what am I missing?
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Well, there is never really "Unlimited" risk to a downside move - of course, in theory the risk could be basically 100% - for example if SPY went to $0 - which would be really bad for the market anyway! Truly unlimited losses are usually reserved for shorting stocks and/or calls that aren't covered. Even that usually isn't really unlimited, but could possibly be several fold what the investment was.

So just to clarify - let's pretend there is a stock XYZ at $60 - you see that the 55 calls sell for $1000.
If you buy 100 shares, and sell 1 55 call, you will have paid
$5,000.
That is your theoretical risk then, if the stock fell to $0. You paid $6000 for the stock, but got $1000 for the Covered Call. You can't lose more then $5,000 without adjustments, etc. However if the stock fell to $0 and never came back (like Enron or whatever), you would basically lose $5,000.

Of course, a loss of this size is less likely with ETFs and indexs, etc.

JJacksET4
 
Quote from JJacksET4:

Well, there is never really "Unlimited" risk to a downside move - of course, in theory the risk could be basically 100% - for example if SPY went to $0 - which would be really bad for the market anyway! Truly unlimited losses are usually reserved for shorting stocks and/or calls that aren't covered. Even that usually isn't really unlimited, but could possibly be several fold what the investment was.

So just to clarify - let's pretend there is a stock XYZ at $60 - you see that the 55 calls sell for $1000.
If you buy 100 shares, and sell 1 55 call, you will have paid
$5,000.
That is your theoretical risk then, if the stock fell to $0. You paid $6000 for the stock, but got $1000 for the Covered Call. You can't lose more then $5,000 without adjustments, etc. However if the stock fell to $0 and never came back (like Enron or whatever), you would basically lose $5,000.

Of course, a loss of this size is less likely with ETFs and indexs, etc.

JJacksET4
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Ok now I understand.

Yeah, when I see "unlimited losses" I interpret that as "potentially more than you spent/end up owing someone money," such as, like you say, shorting stocks or uncovered calls.

I was trying to figure out where the "unlimited" came in, like if I wrote my 120 call for my 100 shares of SPY and somehow ended up owing like $100,000 or something.
 
Quote from JJacksET4:

Well, there is never really "Unlimited" risk to a downside move - of course, in theory the risk could be basically 100% - for example if SPY went to $0 - which would be really bad for the market anyway! Truly unlimited losses are usually reserved for shorting stocks and/or calls that aren't covered. Even that usually isn't really unlimited, but could possibly be several fold what the investment was.
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Having a short SPY position rise 10 pts is no more painful than have a long SPY position drops 10 pts. It's just 2 sides of a coin.

Don't get hung up on the fear of unlimited risk of shorting. Markets don't melt up and anecdotally, they drop 2-1/2 times faster than they rise. Given the opportunity, I'd sooner trade from the short side than the long side.
 
Quote from spindr0:

Having a short SPY position rise 10 pts is no more painful than have a long SPY position drops 10 pts. It's just 2 sides of a coin.

Don't get hung up on the fear of unlimited risk of shorting. Markets don't melt up and anecdotally, they drop 2-1/2 times faster than they rise. Given the opportunity, I'd sooner trade from the short side than the long side.
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Of course you are right, but I was just trying to make it clear that going long for say $5,000, you might risk $5,000, but going short, you could lose more then that for example. Of course, this kind of scenario can also be true shorting a call or put as opposed to going long the call or put (possible losses of multiple times the credit received, compared to losing "only" 100% of a debit.).

Of course, I know you already know this stuff, but just to try clarify what I was trying to say. :)

JJacksET4
 
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