Questions on covered call

[vr_ganesh]

I read a lot about the covered call options, but still I am confused. Kindly help me.

Following is the scenario I would like to get validated / clarified.

The assumption is that I am ready to keep Infy shares whatever price it comes down to.

1. I buy 200 Infosys at the spot price of 1250 on Jan 1. I will be paying 1% * 200 * 1250 = 2500 as brokerage

2. I sell Jan 26 CALL option at 1350 at preminum of 10. So I will be getting 200 * 10 = 2000 in preminum. Brokerage will be 0.05% * 200 * 1350 = 135. So my net premium is 2000 - 135 = 1865.

3. Now we have these 4 cases

3a. Infy price never reaches 1350 before Jan 26. In this case I don't do anything and let the option expire. I retain 1865 as my profit. I can write another CALL option for Feb.

3b. Infy is 1355 on Jan 26. In this case also I don't do anything and let the option expire. The broker will debit (1355 - 1350) * 200 = 1000 from my bank account. So my net profit is 850.

3c. Infy is above 1350 on Jan 20. I want to close out the option and sell my shares in the spot market. How do I do this? Should I square off? If I sell at 11.00 AM at Rs. 1400, and the closing price is Rs.1500, then what will be my net profit / loss (should I even worry about what would be the closing price, or in other words should I worry about the price I am selling my shares that there could be any losses in the options) ?

3d. If I don't do anything with option 3c, and I let my option it run. Infy is 1450 on Jan 26. What should I do now? When should I sell the shares and when should I square off?

Kindly help me.

 

[AW10]

Covered call is bullish strategy so to be profitable in this over long range, stock needs to move up. If Infy goes to 800, u are going to loose. As long as that is understood, it is fine.

3a. Infy price never reaches 1350 before Jan 26. In this case I don't do anything and let the option expire. I retain 1865 as my profit. I can write another CALL option for Feb.

Yes. Call will expire worthless and no action needed. 1865 is yr profit (or monthly rent on the asset of Infy stock) .

3b. Infy is 1355 on Jan 26. In this case also I don't do anything and let the option expire. The broker will debit (1355 - 1350) * 200 = 1000 from my bank account. So my net profit is 850.

Right. You get little less rent of 850 in this case

3c. Infy is above 1350 on Jan 20. I want to close out the option and sell my shares in the spot market. How do I do this? Should I square off? If I sell at 11.00 AM at Rs. 1400, and the closing price is Rs.1500, then what will be my net profit / loss (should I even worry about what would be the closing price, or in other words should I worry about the price I am selling my shares that there could be any losses in the options) ?

Closing price doesn't matter here. If you are selling shares at 1400 then thats what u will get in yr acct. Make sure u also buyback the option and close the liabilty taken by short option. Option will be loss at this time because it is already worth 50 rs (i.e 1400-1350 = 50 rs.) and add some time premium to it.
so u will be buying back the option at 50rs or more. Due to poor liquidity of stock options in our market, u might end paying any arbitrary number at that time (it is possible ..say the seller is ready to sell only at 80rs though it not worth more then 60rs)

3d. If I don't do anything with option 3c, and I let my option it run. Infy is 1450 on Jan 26. What should I do now? When should I sell the shares and when should I square off?

If you don't take any action given in 3c, then on the day of expiry, you option position will be settled and amt = (1450-1350)*200 = 20000 will be debited from yr acct. Nobody will sell yr stocks automatically. So if you want to realise the profit n stock then sell that at 1450 and book profit. Part of that profit will go towards settlement of 20k, and remaining profit, which shd be (strike price of option - yr purchase price of stock) will remain with u.

Happy Trading.

 

[vr_ganesh]

Thank you very much for your kind help AW10. That was very quick and clear. May god bless you for helping newbies like me.

Yes. I understand that if Infy reaches 800, I am going to loose big time. But I am OK to hold Infy.

Just a few clarifications needed from your reply.

Make sure u also buyback the option and close the liabilty taken by short option.

1. So I squareoff the options at let's say Rs. 80. Then my profit from selling the shares is (1400 - 1250) * 200 = 30000. Brokerage = 1% * 1400 * 200 = 2800. So my net profit from my cover = 30000 - 2500 - 2800 = 24700. Loss from my options = (80 - 10) * 200 = 14000. Brokerage = 0.05% * 1320 * 200 = 135. So my net loss from my options = 14000 + 350 + 350 = 14700

So my net profit = 24700 - 14700 = 10000

Are my calculations correct?

So if you want to realise the profit n stock then sell that at 1450 and book profit.

2. How will I know 1450 is the price at which I have to sell my stock? When will I know that? If it is on Jan 26, at 300 PM, then will it not be too late for me to close it at the same exact price? There could be sme 10 - 20 Rs wild swings. Am I exposed to those risks?

3. Also what if 1450 is some intraday price anytime between Jan 1 and Jan 26, and the buyer exercise his rights. If I see the exercise after a few hours / days at 1450, and by then if Infy had come back to 1400, then am I exposed to the risk of selling Infy only at 1400? Or in other words will I be under risk for not monitoring my open positions every minute?

 

[AW10]

Just a few clarifications needed from your reply.
1. So I squareoff the options at let's say Rs. 80. Then my profit from selling the shares is (1400 - 1250) * 200 = 30000. Brokerage = 1% * 1400 * 200 = 2800. So my net profit from my cover = 30000 - 2500 - 2800 = 24700. Loss from my options = (80 - 10) * 200 = 14000. Brokerage = 0.05% * 1320 * 200 = 135. So my net loss from my options = 14000 + 350 + 350 = 14700

So my net profit = 24700 - 14700 = 10000

Are my calculations correct?

Yes. Your calculation is correct.

2. How will I know 1450 is the price at which I have to sell my stock? When will I know that? If it is on Jan 26, at 300 PM, then will it not be too late for me to close it at the same exact price? There could be sme 10 - 20 Rs wild swings. Am I exposed to those risks?

1450 was just a number I used from your original question 3c. This helped in explaining the calculation. In practice, it will the market price that u get when
you decide to sell the stock and book profit. Yes there might be few points slippage in real transaction. You can get a fair idea about this by answering "how much infy can move at max in a 30min period ?".

3. Also what if 1450 is some intraday price anytime between Jan 1 and Jan 26, and the buyer exercise his rights. If I see the exercise after a few hours / days at 1450, and by then if Infy had come back to 1400, then am I exposed to the risk of selling Infy only at 1400? Or in other words will I be under risk for not monitoring my open positions every minute?

Well thought out questions. This is tricky part and carries the risk as u have mentioned. If buyer of option excercises his right, and you get assigned, you will come to know only after the market when settlement takes place.
Unfortunately broker (atleast my brokers) might not inform u that ur short option is assigned but they will jsut post the accounting entries to debit yr acct. If there is margin call, then probably they will call u to pay the margin.
So u got assigned today, and u come to know about it tonight then earlies u can sell the stock is tomorrow.. So u carry the risk here and it is possible that Infy might trade tomorrow below the settlemnt price of today.

But thats what trading is all about. There is always some amount of risk and as a trader we need to manage the risk.

I like the way you have put them across and amount of prepration that has gone in this. Keep it up.

Happy Trading