Covered calls

November 16th, 2005 by Kenric

I guess this is the first stock post. I have many shares of Ebay and it’s been hovering at $40 forever. I’ve been making a few hundred here and there selling covered calls. I decided to sell a covered call on 500 shares for December. I am selling the right for someone to buy Ebay stock at a certain price until the third Friday in December (in this case it’s $45). The person is paying $1.05 for this right. So I make about $500 immediately.

This is called a covered call because I have the stock in my account. It would be a naked call if I didn’t have the shares that I sold the rights to.

Now what happens is that if Ebay is below $45 when the third Friday in December comes, the option will expire and I keep my Ebay stock and the $500. I can sell another covered call immediately after.

If Ebay is above $45, the person will exercise the option and purchase my 500 shares of Ebay from my account at $45.

Now imagine if I didn’t have the Ebay stock in my account. Let’s say Ebay was at $50 and the person exercises the option. He is buying Ebay at $45, but I don’t have Ebay so I have to go on the market and pay $50 a share for it. I will pay the difference, $5 X 500 shares, $2,500 total. I only got $500 for the option, so I would have lost $2,000 on this.

I use covered calls to make a little money on stock I want to sell anyway. If they don’t sell, I just write another call.

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