Steve Stermer: “I have a basic question about call options that I’ve never understood. Say I have 100 shares of IBM which is trading around $130 right now. The strike prices for September calls range from $80 to $150. What could be the benefit of selling a covered September $80 call when the stock is trading at $130 today? Of course, I would receive a $5000 premium for selling the call, and I’d certainly be called out next month and receive another $8000 from that sale, for a total of $13000. But why would I do THAT when I could sell a $140 call instead, receiving a $300 premium now, and (worst case) another $14000 from the sale next month, for a total of $14300 (10% more return in the same amount of time)? Why the market for all these low end call options?”
☞ You’re right. No one would initiate the sale of a new IBM 80 call when the stock is 130. That is, no one would call his broker and say, “I want to write some IBM 80 calls.” But what you’re forgetting are the people who bought IBM 80 calls, back when IBM was selling closer to that price. Some of those people may want to sell. Maybe they need cash to put down on a new house. Maybe they think IBM is going to drop.
If someone who bought an IBM 80 call now wants to sell, he will take what he can get. Which in this case will be roughly the intrinsic value of the option, plus maybe a hair of premium. (The longer it has to run, the thicker the hair.)
Let me not forget the larger point, however: Buying and trading options, you will, gradually or spectacularly, lose your money.
Not all of it, perhaps — and perhaps none of it writing covered calls (that is, owning IBM stock and then selling someone the right to call it away from you).
But even writing covered calls, you’re unlikely to come out ahead in the long run: First, you still expose yourself to a large loss if the stock should plummet. Second, you limit your potential gain if the stock shoots up. Third, you risk getting whipsawed if the stock rises and — to avoid having it called away and exposing you to a taxable gain — you buy back the call at a loss. You do that and, invariably, the stock goes back down, to taunt you.
Quote of the Day
Beware of little expenses. A small leak will sink a great ship.~Ben Franklin
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