Timing Options, Part 1
Sunday, June 4, 2006 12:57Tip: Whenever you sell a covered call, be prepared for exercise at any time when the call is in the money. The covered call strategy makes sense only if you are willing to have your 100 shares called away.
During the life of a call, the underlying stock might swing several points above or below striking price. If you own 100 shares and are thinking of selling a covered call, keep these points in mind:
· When the striking price of the call is higher than the original price you paid for the stock, exercise is not a negative; it automatically triggers a triple profit—from appreciation of the stock, call premium, and dividend income.
· If you sell a call for a striking price below your original cost of stock, be sure the premium you receive is greater than the loss you will experience in the stock in the event of exercise.
· In calculating potential yields, be sure to allow for trading costs on both stock and option, and for both entering and leaving the positions.
· For the benefit of producing a consistent profit from writing calls, remember that you give up the potential for greater gains if and when the stock’s current market value rises.
· The tax consequences of covered call writing have to be included in your calculation, especially if you have a substantial paper gain in the stock and have owned that stock long enough that gains would be long-term. In instances when you write in-the-money calls against stock, you could lose the long-term status of stock, so tax planning has to be a part of your strategy unless you restrict your short positions to out-of-the-money contracts.
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