Help me understand what happens here: writing covered ITM calls?

Discussion in 'Options' started by 1a2b3cppp, Mar 27, 2011.

  1. Ok, if I sell a call option then I get the premium.

    Ok say I own 100 shares of SPY.

    Looking at Yahoo's option chains, an April 85 call for SPY is $44.10 (

    So if I were to sell that option, I would be paid $4,410, right?

    So if I just bought the shares on Friday and paid $131 for them, so that cost me $13,100. Then I got $4,410 for the option, so my cost is $8,690 ($13,100 - $4,410).

    So what happens then? When expiration day comes around I have to sell my shares at $85, so $8,500 total? So is my total profit then $8,690 - $8,500 = $190?

    And would that be my total profit no matter where the price of SPY went, as long as it was above $85/share and the option is ITM?

    What else can happen in this situation? Is there any case where I'd have to buy the option back or something?
  2. You have nearly 1K post in ES and I though you should be experience trader ?

    Buying DIM call options and long the underlying ,and let it get called away so that you can earn some premium for the DIM call is a known methods, you are right, you are ok as far as SPY never tanked below $85, just treat $85 call as your insurance (which protect you until the price tank below $85)

    You no need to do anything in expiration as your underlying (SPY) will get called away automatically.

    Alternatively you can short the $85 Put. Same risk profile

    In real life, it is a rare case that you can sell any DIM options with some additional premium which is 0.19 in here (the other side, mostly MM is not that stupid).

    Long time ago, there is a guy doing the reverse of this strategy he short the stock and short the DIM put on AAPL, and he claimed that AAPL will NOT hit his insurance level based on his professional evaluation (accouting) of the company that the stock that will not rise forever. I recalled AAPL was around $180 that time. I never heard anything back from this guy anymore this day, mostly due to AAPL is indeed go to $350 and he loss his pant :D Long story short, there is NO risk free trade., same thing can happen to SPY.
  3. I don't know much about options. I've been trading stocks and futures for years but have never been interested in options until just recently.

    I didn't know there was supposed to be a direct correlation between number of posts on ET and amount of trading knowledge amassed. I will talk to an ET mod about getting my post count reduced since apparently I am supposed to know about options based on my number of posts.

    Buying DIM call options? I'm asking about selling.

    I'm not sure I understand what you're saying.

    I know there is no risk free trade. I was mostly just asking if I had the concept and the math right in my post. Options confuse me. Every time I think I understand it, I realize therw was something I was overlooking [​IMG]
  4. Typo, i mean selling - you short the DITM call and long the underlying at the same time, with the expectation SPY won't tank below $85 and your SPY will get called away during expiration (automatically exercised by the DITM short call).

    It is almost impossible to find arb (risk free money) in option this day. Most of the concept (99.999%) of the free money already been exploited and you won't find any more here.

    i am jealous you are posting more than me in ET :D
  5. donnap


    A few mistakes there.

    The cost basis is 8690 less 8500 (strike value) = -190 loss.

    The option had 0 volume and OI was 1. No liquidity.

    Looking at the 44.10 last sale, we see it was a Jan. 24 trade.

    With SPY at 131.30 yahoo shows the current bid for the call at 46.30 or parity. There is no profit in this CC write, either.
  6. I knew it.

    Wait, what?

    Crap I didn't notice that.

    OK, new example for one that actually has some liquidity.


    April 120 call.

    Let's use the lowest listed price (bid) which is 11.50.

    So I have 100 shares of SPY @ 131 = $13,100.

    Then I sell an Apil 120 call for $1,150.

    Now my total expense so far is $11,950, right?

    Now if the option expires ITM (eg. SPY price is above 120) then I have to sell my shares for $12,000, right? Which brings my totals to:

    -13,100 (initial purchase of 100 shares at 130)
    + $1,150 (premium collected from selling the option)
    + $12,000 (sale of SPY at 120 when option expired ITM)
    $50 (which is probably closer to 0 after commissions)

    is that math correct?

    So basically, if SPY is anywhere above 120 then I make a total of $50, and the more it is above $120, the more money whoever bought my option makes.

    And then if SPY goes below $120, the option expires worthless and I keep the premium AND my shares, right?

    Is that correct, and are there any other possible outcomes?
  7. Without looking at your example in too much detail, it basically looks right - selling the 120 brings $1150 and you lock in a max gain of $50, with large possible loss if SPY falls below $120.

    Just to point it out, I quickly knew the 85 strike example was wrong, because if you look at the 85 strike puts they are only worth about 3 cents. The puts should be worth about the time value of the calls give or take some based on bid/ask spread, etc. Also, it was correct of the other poster to point out the difference between bid/ask and last.

    As has been mentioned on here many times, instead of buying the stock and selling the covered call, you could just sell the same put and then put the other money in a interest yielding account for example (and only have the put sale commission, not the stock purchase commission). If SPY stays above the strike, the puts expires worthless and you keep the premium. The risk is really the same, but some people make it worse by selling for example 5 puts where they would only do 1 of the covered call.

  8. Yes, you have it correct.

    It's not a trade that has much arbitrage built in, which I believe is what you were seeking.

    arbitrage (def): the nearly simultaneous purchase and sale of securities in different markets in order to profit from price discrepancies.

  9. Wait, how do I lose money if price goes below the strike.

    If price goes below the 120 strike price then the owner of the call has the right to buy the shares at 120, but why would he want to? They're cheaper at market price.

    How do I lose money in that situation? Wouldn't I just keep the shares then since the person who bought the call doesn't want to buy them for 120?
  10. donnap


    You seem to have the mechanics down.

    The option prices are based on SPY = 131.30.

    If you bought at 131, then you should compare the $50 CC profit to the current $30 realizable profit.

    One other possible outcome is called pin risk. If SPY was trading at 120 (the call strike) at April expiry, then you wouldn't know if the calls would be exercised or not. SPY only has to trade near the strike to create uncertainty - and AH prices may impact the probability of assignment. So you couldn't be certain what your position was going to be after expiry.

    Not applicable here, but the evening before ex-div. usually sees the early exercise of nearly all front month DITM calls - or any ITM call whose FV is below parity. Of course, early assignmemt may be a good thing. However, you'd have to weigh the div. vs. assignment and possibly roll up and/or out the CC write.
    #10     Mar 27, 2011