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In a Rising Market
If the market is rising, you can choose a strike price that is slightly above the actual stock price. Accordingly, if the call option is exercised (assigned), your
income will be the call premium on the sold option plus the appreciation of your stock value. This technique can enhance your stock investment gains by several percent.
If we take the previous example but compare it to the Out-of-the-money Covered Call Example:
GM at $30.88 per share
Sell GMIZ SEP 32.50 strike for $0.65
Appreciation = Strike Value - Buy Value
Appreciation = $3,250 - $3,088
Appreciation = $162.00
% if Assigned = [Option Income + Appreciation] ÷ [Buy Value - Option Income]
% if Assigned = [$65.00 + $162.00] ÷ [$3,088.00 - $65.00]
% if Assigned = 7.5% (if your stock gets assigned at $32.50 to cover the short option)
Of course, the OTM trade will only offer the investor a 2% Downside Protection
Downside Protection = Option Income ÷ Stock Price
Downside Protection = $0.65 ÷ $30.88
Downside Protection = 2%
Also stocks generally moves in up/down cycles and not in a straight line. The price will spurt upward for several days and then
decline for several days. Stock purchases should be made on dips and the call selling should be done on the spurts. This can enhance yields for all cases
of stock movement.
During a rising market the stock is called (call option exercised) more often. When it's called, your stock shares would be sold to the call holder to fulfill
your contract. Subsequently, your covered call position would be complete, you do not own a long stock position or the short call position any longer.
Before your covered option gets exercised, you have two alternatives. This decision is generally made in last three days of trading before expiration of the option:
Summary of Investor alternatives in a rising market
1. Let the stock get called to finish the position and re-purchase this or another stock each month and sell other options to continue the writing call cycle
2. Purchase the option back before it expires.
Deciding which approach is best (1 or 2 above) depends on several conditions. Two examples include tax implications of the stock sale (long term gains) and the cost of commissions for stocks versus options. It generally pays to buy the option back.
The calculations shown in the examples above of % if Assigned (Called) and Downside Protection (Not Called) are the basic calculations that are shown on PowerOptions. These calculations apply to all optionable stocks, which can be searched using PowerOptions Tools by stock price, % if Assigned Return, Downside Protection and other criteria. You can view the calculations and definitions of these returns in the Glossary located in the Help Tool.
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