Selling covered calls, very short term question

[burtonridr]

I was talking to a friend recently about option trading the other day. He said he usually buys 100 shares of a stock he likes, then sells covered calls out three or four months.

Then if he is forced exercise the option he either buys the call to cover or lets the shares go.

Then I started looking into this and I'm looking at "AKS - AK steel", I like the stock and the company. I looked at just the february calls and with the stock price at $8.45 and a strike price at $7.50. Why shouldnt I sell a covered call?

The risk is that I'm called to cover the option and I cover it, then I'm basically just out the cost of commission ($26). The reward would be about $130.

What am I missing? what are the odds that I will be forced to cover the option? What else do I need to consider? etc?

 

[nazzdack]

1) If you initiated a covered-call now and were then immediately exercised, you would gain ~$130 from the short-call, lose ~$100 on the stock because you paid ~$8.50/share AND then sold it at $7.50/share, the strike price, along with commissions and fees.
2) Your position would have been an in-the-money covered-write.
3) If the stock pays a "big" dividend, there's a greater likelihood that you'll be exercised early, i.e. "have your stock called away" and miss out on the dividend.
4) You have to be respectful of the stock losing a lot of value much larger than the option premium.

 

[dagnyt]

Quote from burtonridr:


Then if he is forced exercise the option he either buys the call to cover or lets the shares go.

The seller of a call is never 'forced to exercise.' Only the call owner can exercise an options.

But, he is subject to receiving an 'exercise notice.' That's being told the call owner exercised his rights, and the option seller is now obligated to sell the shares. Might as well lean the language if you plan in using options.

The phrase: 'buys the call to cover OR let's the stock go up" makes no sense. Slow down and try to figure out how this works before getting involved."

Then I started looking into this and I'm looking at "AKS - AK steel", I like the stock and the company. I looked at just the february calls and with the stock price at $8.45 and a strike price at $7.50. Why shouldnt I sell a covered call?

The risk is that I'm called to cover the option and I cover it, then I'm basically just out the cost of commission ($26). The reward would be about $130.

What am I missing? what are the odds that I will be forced to cover the option? What else do I need to consider? etc?

If you plan to buy back the call to prevent losing your shares, then you are, in reality, taking a short position on a stock you like and want to own.

People who believe the stock is moving higher are the ones who buy call options (Don't do that yourself). So selling one now with the intention of buying it back is NOT what you want to do.

It's a good idea to consider writing covered calls, but not the way you describe it.

Read more about this strategy at my blog

Mark
http://blog.mdwoptions.com/options_for_rookies/2008/06/recommended-o-1.html