Bobber's Finance Blog

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  1. Own at least 100 shares of a particular stock
  2. Choose an Option Contract
    • Strike Price – This is the price at which the option buyer can purchase your shares should they get assigned.
      • Choosing a strike price higher than the current stock price is most common (“out of the money”)
      • The more out of the money the option is, the lower the premium.
    • Expiration Date – the date the option contract expires
      • Shorter-term options generally have lower premiums, while longer-term options have higher premiums. This is because you have a greater risk of a stock hitting the strike price if you have more time.
  3. Place the Trade
    • “Sell to Open” Order:
      • You place a “sell to open” order to sell the call option contract
      • One option contract represents 100 shares. So if you have 500 shares of Gamestop (GME), you are able to sell 5 call option contracts.
      • Once you sell an option, you will be paid a premium, which are typically calculated as $ per share.
        • Ex. 1 Option Contract for GME stock at a strike price of $23 is worth $0.27. If you sell this option, you will get $27 credited to your account ($0.27 x 100 shares = $27).
  4. Example:
    • You own 100 shares of Company XYZ, currently trading at $50 per share.
    • You believe XYZ’s stock price will remain relatively stable or rise moderately in the next month.
    • You decide to sell a covered call option.
    • The Trade:
    • Select the Option:
      • You look at the options chain for XYZ and find a call option with a strike price of $55 and an expiration date one month from now.
      • The premium for this call option is $2 per share (or $200 per contract, since 1 contract = 100 shares).
    • Place the Order:
      • You place a “sell to open” order for one XYZ $55 call option contract.
      • Your brokerage account is credited with $200 (the premium).
    • Possible Outcomes:
    • Outcome 1: XYZ Stays Below $55:
      • One month later, at expiration, XYZ’s stock price is $54.
      • The $55 call option expires worthless.
      • You keep the $200 premium.
      • You still own your 100 shares of XYZ.
    • Outcome 2: XYZ Rises Above $55:
      • One month later, at expiration, XYZ’s stock price is $58.
      • The $55 call option is exercised.
      • You are obligated to sell your 100 shares of XYZ at $55 per share.
      • You receive $5,500 ($55 x 100 shares).
      • You keep the initial $200 premium.
      • Your total revenue is $5700.
      • Your profit from the stock is 500 dollars, and your premium profit is 200 dollars.
    • Outcome 3: XYZ drops below your initial purchase price:
      • One month later, at expiration, XYZ’s stock price is $45.
      • The $55 call option expires worthless.
      • You keep the $200 premium.
      • You still own your 100 shares of XYZ, but have a 500 dollar loss on the shares.
    • Key Takeaways:
    • In Outcome 1, you achieved your goal of generating income while keeping your shares.
    • In outcome 2, you made a profit, but missed out on the $3 per share gain above the $55 strike price.
    • In outcome 3, you still gained the premium, but have an unrealized loss on the shares.

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