How to Pick the Right Short Call For a Safe Investment Strategy
If you are selling calls to provide income for your stock portfolio, you need to understand which option to sell.
You could sell an option very close to the stock price (At-the-money).
You could sell an option below the stock price (In-the-money).
Or, you could sell an option above the stock price (Out-of-the-money).
There is a balance between profit and safety.
Understanding it can give you a safe investment strategy.
Let's look at the relative merits of each.
We'll pick on Apple Computer (AAPL) as our example.
On November 18, 2008.
AAPL closed at about $90.
That day you could have sold the Dec 90 option for 8.
35.
One strike out of the money, Dec 95, was 6.
10, and one strike in the money Dec 85 was 11.
10.
Which one will be more profitable? Well it depends on where the stock closes at expiration, the third Friday in December.
Here's a matrix that shows you how you might do.
If the stock closes at 100 you would see the following return for each option: Dec85: 8% Dec90: 10% Dec 95: 13% No Option: 11% If the stock closes at 90 you would see the following return for each option: Dec85: 8% Dec90: 10% Dec 95: 7% No Option: 0 If the stock closes at 85 you would see the following return for each option: Dec85: 8% Dec90: 4% Dec 95: 1% No Option: -6% If the stock closes at 80 you would see the following return for each option: Dec85: 1% Dec90: -2% Dec 95: -5% No Option: -11% Here are some of the key observations from this data.
o If you value downside protection, select the ITM option.
The Dec 85 provided 8% return for the month even if the stock fell from 90 to 85, and it did not lose money down to 80.
o The ATM option always provides the highest return in a perfectly flat market.
In this case it gave you 10% return for the month with no movement of the underlying stock.
o The OTM option provides the best opportunity for the highest return, but the stock price has to rise to get it.
o Even the OTM cut the monthly loss in half over not having any option at all.
The bottom line: you have to have an idea where you think the stock is going over the coming month.
If you don't know, select the ATM option; it provides the highest return in a flat market.
If you are concerned and need extra safety, go down into the options table a strike or two.
This will give you some return with some extra safety.
You could sell an option very close to the stock price (At-the-money).
You could sell an option below the stock price (In-the-money).
Or, you could sell an option above the stock price (Out-of-the-money).
There is a balance between profit and safety.
Understanding it can give you a safe investment strategy.
Let's look at the relative merits of each.
We'll pick on Apple Computer (AAPL) as our example.
On November 18, 2008.
AAPL closed at about $90.
That day you could have sold the Dec 90 option for 8.
35.
One strike out of the money, Dec 95, was 6.
10, and one strike in the money Dec 85 was 11.
10.
Which one will be more profitable? Well it depends on where the stock closes at expiration, the third Friday in December.
Here's a matrix that shows you how you might do.
If the stock closes at 100 you would see the following return for each option: Dec85: 8% Dec90: 10% Dec 95: 13% No Option: 11% If the stock closes at 90 you would see the following return for each option: Dec85: 8% Dec90: 10% Dec 95: 7% No Option: 0 If the stock closes at 85 you would see the following return for each option: Dec85: 8% Dec90: 4% Dec 95: 1% No Option: -6% If the stock closes at 80 you would see the following return for each option: Dec85: 1% Dec90: -2% Dec 95: -5% No Option: -11% Here are some of the key observations from this data.
o If you value downside protection, select the ITM option.
The Dec 85 provided 8% return for the month even if the stock fell from 90 to 85, and it did not lose money down to 80.
o The ATM option always provides the highest return in a perfectly flat market.
In this case it gave you 10% return for the month with no movement of the underlying stock.
o The OTM option provides the best opportunity for the highest return, but the stock price has to rise to get it.
o Even the OTM cut the monthly loss in half over not having any option at all.
The bottom line: you have to have an idea where you think the stock is going over the coming month.
If you don't know, select the ATM option; it provides the highest return in a flat market.
If you are concerned and need extra safety, go down into the options table a strike or two.
This will give you some return with some extra safety.
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