Chris Rowe

4 Ways to Generate Instant Options Profits

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Now, take a look at the difference.

How Will This Trade Work Out?

There are four possibilities:

1. BOBC trades to $60.

Your stock position in BOBC is called away (sold) at $60 per share and, instead of $10,000, you net a profit of $12,000. (You paid $50,000 to buy the stock and sell it at $60,000. That's a profit of $10,000 on the stock plus $2,000 on the option that you sold.)

Special note: Your stock will not necessarily be sold at $60 just because it trades above $60. Your stock may or may not be called away at any time before expiration. If, at 4 p.m. on expiration Friday, the stock is 25 cents in-the-money or more (which means BOBC would be trading at $60.25 or higher), then the call that you wrote will automatically be exercised, and your stock will automatically be "called" away (sold) from you.

Here is a quick picture of what this would look like.

2. BOBC trades down.

You don't feel so bad because you picked up that extra $2,000 from writing the covered call. If you didn't "sell to open" that call option, BOBC would have still traded lower, but your account would be worth $2,000 less than it is worth right now! Whatever dollar amount the stock trades down by, the decline in value is reduced by $2,000.

If, after you take in that $2 premium, your stock trades from $58 down to $55, then instead of losing $3,000 in value, your 1,000 shares of BOBC would lose $1,000 in value since you will have been paid $2,000 for the call option that you sold. So if the stock trades down 3 points, you really only lose 1 point in value, because while the stock lost 3 points, you made 2 points by selling the call option.

At least you take in an extra $2,000, and you will be free of any future obligation once the option contract expires. (Or else you can just close out the call option position by buying the same call back (i.e., "buy to close") at its current lower price (see below).

Now, here's a fun twist: You actually have two choices if your stock trades lower.

a) You can do nothing and maintain both the "long" stock position, as well as the "short" call option position, until the option contract expires.

b) You can simply buy the option contract (that you previously sold at $2) at a cheaper price. Imagine selling a gold watch for $2,000 and then buying it back from the person that you sold it to for $300. Not bad. That's a $1,700 profit.

As the stock trades lower, the call option that you sold also trades lower. This means that if the stock trades lower, you can always buy the call option (that you've sold) at a cheaper price than what you received for it when you sold it. This is a profit on the option trade that will reduce the loss incurred on your stock position. Once you buy back the call that you shorted, your position is closed (i.e., "covered") and you are no longer at risk for assignment, or having your stock called away.

For example, if BOBC trades from $58 down to $55, then the call option that you sold at $2 (to open) might trade down to 30 cents. You can now buy the call option at 30 cents (to close). That's a difference of $1.70. Since you originally sold (or shorted) that call option at $2, that $1.70 difference is a profit.

Said differently, if BOBC traded from $58 to $55, the stock position lost $3 in value. But since the call option that you sold at $2 (to open) is now at 30 cents, you have a profit of $1.70. So the net result is that, instead of your position losing $3 in value, it really only lost $1.30 in value.

In other words:

Stock lost $3
Option gained $1.70
Total loss is $1.30

Or -- as I said originally -- you can let the option expire worthless and realize the entire $2 gain on the call. In this case, if the stock traded from $58 to $55, then your entire position would have lost $1 in value instead of $3.

Stock lost $3
Option gained $2
Total loss is $1

After the option expires, you are free of your obligation. If you wish to do so, you can sell another call option and start the process over again.