Completed PALM covered call position

I've finished legging in to my PALM covered call options position. The February call, with a strike price of 13, sold for an 83-cent premium with the underlying stock trading at 12.95

I opened the first leg of the position yesterday, buying the stock for 12.63.

Here's the potential profit of the completed position, which expires Feb. 19. (I've ignored the trading fees that are part of doing business.)

• If the stock is in-the-money -- that is, the price is 13 or higher -- then I'm obligated to sell the stock for 13, no matter how high it has gone on the market, for a 37 cent profit, and I get to keep the premium from the option, giving a total profit of $1.20. Not bad for 20-days work.
• If the stock is out-of-the-money -- the price is below 13 -- then I keep my shares and the 83-cent premium.

If I keep the shares, in the out-of-the-money scenario, then I can sell another covered call against the stock. I would only want to do that if the price was high enough to ensure that I earn a profit on the shares if they were sold at the strike price of the option, or that the loss is small enough to be covered adequately by the premium from selling the new call.

As a rule of thumb, say I'm willing to lose a dime, so I would sell a new 13-strike covered call if the price was trading at 12.53 or higher. (Remember, I bought the shares for 12.63.) If the stock moves up to 14 or even higher, then I shall happily sell a call for that higher strike, because I'll have greater profits if I'm forced to sell the shares.

Best potential profit: 9.5 percent. Not bad for a month's work.

My break-even point has been lowered to 11.80 (the stock price of 12.63 minus the option premium of 83 cents). So I weather a 6 percent decline and still be profitable.




New to Private Trader? Check out the Reader's Guide.
Topics:
Palm smartphones cellphones