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Notice IBM stock closed at $121.88/share, up $0.06 from previous trading
day. We can buy 100 shares of IBM stock at $121.88/share today and sell 1
contract of covered call for the month of October.
We have three scenarios here:
Case 1: We sell IBMJE call
for $2.05/share or $205/contract. If IBM stock closed above $125/share by
the end of October 16th, our IBM stock is called out. We make
$5.17/share or 4.24% in about a month. IBM stock needs to move past $125
for us to make money.
Case 2: We sell IBMJD call
for $4.50/share or $450/contract. If IBM stock closed above $120/share by
the end of October 16th, our IBM stock is called out. We make
$2.62/share or 2.15% in about a month. IBM is already traded above
$120/share when we sell our cover call; hence, we have a better chance
for a profitable trade.
Case 3: We sell IBMJC call
for $8.10/share or $810/contract. If IBM stock closed above $115/share by
the end of October 16th, our IBM stock is called out. We make
$1.22/share or 1% in about a month. IBM is traded $6.88 above $115 strike
price. We have a pretty good chance of being called out by October 16th.
Please notice when we sell covered call deeper in-the-money option;
we increase our chance for a profitable trade. The price we pay for this
higher probability is lesser profit. The covered call strategy works for
a side way and up trending market. This strategy offers no or very little
protection in case of a severe drop in the market.
A side note: Let’s look at the short call/long put
from last lesson.
The IBM option chain for September 2009 by the end of September 17th
should look like the following table:
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