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

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

  1. You're talking about selling a call, right?

    So, if SPY falls to say $80, you paid almost $12,000 for a position now worth $8,000. So, yes, you keep the shares, but they are worth a lot less then your total expense was. Of course, it may not be a realized loss until you actually sold the shares.

    JJacksET4
     
    #11     Mar 27, 2011
  2. Oh. When I saw the risk/reward graph for a covered call, it showed potentially unlimited losses, so I thought I was missing something.

    But how is it unlimited? You've got the cost of the premium + what you paid for the stock. Even if the stock goes to zero, that's not unlimited.

    So what am I missing?
     
    #12     Mar 27, 2011
  3. owning the stock means you are long
    selling a call in the money means you think the stock is going down

    :confused: don't like that
     
    #13     Mar 27, 2011
  4. Well, there is never really "Unlimited" risk to a downside move - of course, in theory the risk could be basically 100% - for example if SPY went to $0 - which would be really bad for the market anyway! Truly unlimited losses are usually reserved for shorting stocks and/or calls that aren't covered. Even that usually isn't really unlimited, but could possibly be several fold what the investment was.

    So just to clarify - let's pretend there is a stock XYZ at $60 - you see that the 55 calls sell for $1000.
    If you buy 100 shares, and sell 1 55 call, you will have paid
    $5,000.
    That is your theoretical risk then, if the stock fell to $0. You paid $6000 for the stock, but got $1000 for the Covered Call. You can't lose more then $5,000 without adjustments, etc. However if the stock fell to $0 and never came back (like Enron or whatever), you would basically lose $5,000.

    Of course, a loss of this size is less likely with ETFs and indexs, etc.

    JJacksET4
     
    #14     Mar 27, 2011
  5. Ok now I understand.

    Yeah, when I see "unlimited losses" I interpret that as "potentially more than you spent/end up owing someone money," such as, like you say, shorting stocks or uncovered calls.

    I was trying to figure out where the "unlimited" came in, like if I wrote my 120 call for my 100 shares of SPY and somehow ended up owing like $100,000 or something.
     
    #15     Mar 27, 2011
  6. spindr0

    spindr0

    Having a short SPY position rise 10 pts is no more painful than have a long SPY position drops 10 pts. It's just 2 sides of a coin.

    Don't get hung up on the fear of unlimited risk of shorting. Markets don't melt up and anecdotally, they drop 2-1/2 times faster than they rise. Given the opportunity, I'd sooner trade from the short side than the long side.
     
    #16     Mar 27, 2011
  7. Of course you are right, but I was just trying to make it clear that going long for say $5,000, you might risk $5,000, but going short, you could lose more then that for example. Of course, this kind of scenario can also be true shorting a call or put as opposed to going long the call or put (possible losses of multiple times the credit received, compared to losing "only" 100% of a debit.).

    Of course, I know you already know this stuff, but just to try clarify what I was trying to say. :)

    JJacksET4
     
    #17     Mar 28, 2011