When online options trading involves Covered Calls, what happens when the price moves above the option sold and you are assigned the stock. This article will cover both covered calls involving stock and a long term option and assumes that you already know the mechanics of option trading and know what a Covered Call is. I am an individual online trader who has encountered the scenarios below. I make no claims as to the accuracy of the data but this is has been my experiences.
Trading online is risky and you must check with your brokerage house for each situation.
What is Assignment?
An assignment is when the option you sold against the stock is exercised and you must turnover the stock to the buyer. This usually only happens when the stock price has risen above the strike price of option sold and usually occurs on expiration Friday, but can occur sooner.
Can You Lose Money?
The answer is; it depends.
1. If you owned the stock and the purchase of the stock was less than the strike price of the option sold at assignment, you will keep the amount you received when selling the option plus the difference between purchase of the stock and the strike price of the option sold as profit.
Example: You buy the stock for 25.67 and sold a $30.00 strike price. Stock rose to $33.23. You would get to keep $4.33 (1 share) in profit. ($30.00 - $25.67 = $4.33.)
2. Selling a Covered Call against a long term option gets a little trickier and the potential for loss is greater.
Example: You buy an October $35 option against a stock and sell an August $30 call. The stock price rises to $33.23. you will keep the premium on the option sold, the stock will be delivered to the buyer at $30 per share, and you will be assigned a short sale of the stock and be obligated to cover the stock (buy it back). You will receive $30 per share in your account for the sale of the stock. This would be a loss of $3.23 per share on the trade if you immediately bought the stock back. ($33.23 - $30.00 = -$3.23).
You do have some potential for recovery. Depending on the brokerage house you, may be able to hang onto the short sale in anticipation of stock price dropping below the strike price sold and then buy to cover the stock when the price is down. Also, as the price of the stock has risen, the premium on your October option should have also gone up in value. You can sell this option and to some of the loss.
Over the years I have traded covered calls many times and use this as one method to generate income. I have also lost money when trading a Covered Call against a long term option when I got careless and didn't monitor the stock too closely. If trading a Covered Call against an option, you must monitor the stock movement. If the price of the stock starts getting close to the strike price of the option sold, consider buying back the option sold. Yes, you may lose some money on the covered call transaction but now you can hang onto the long term option and may gain some profit back when selling.
Happy trading...
Chuck Ainsworth
http://articlesbychuckytrader.com
For more information on a great product to help you with online stock, options, forex and commodities trading visit my website at http://www.storesbychuckytrader.com/LightWave.html. With LightWave you will have the charts and manual control of all your trading needs.
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