Sell the Call! …But then the Stock Soars

In the last post we discussed how an open sold call option works as a hedge as the stock price goes down. In this post I’ll discuss how an open sold call option behaves when the stock price goes up above your strike price. In another post about the process of choosing a strike price, we discussed creating a “win-win” situation for yourself, where are you are happy of the result either way. For example, you sell a 60 day call option at a $90 strike price for $150, your break even point is $91.50 ($9,000 + $150) and you are just as happy if within that time the stock price stays at ≤$93. If it’s within that window you did not miss out on much, and if it’s much less, then you don’t sell the stock anyways and you keep your $150.

What if the stock price goes well above the strike price while you have an open sold call option? The call option becomes more and more expensive for you to close out (buy back). For example, you take a premium of $150 by selling a 60 day call option at a strike price of $90, then the stock price goes up to $95. The total value of your 100 shares sold at $95 each would’ve been $9,500, but you are committed to breaking even at a total profit of $9,150. This chart displays these numbers in a way that you can visually see the break even point at the intersection of the blue and yellow lines.

chart (13)

You could have bought back the call option earlier if you had seen this coming, or maybe the stock went up that high all at once. But if you read my other posts then you already took your calculator out and figured out what percentage gains you were potentially locking yourself into by signing the contract, and I hope it was over 10%, as that is my happy zone to be in.

In conclusion: Choose a satisfying ROI and stick to your plan.

Thanks for reading. Comment and ask questions anytime.

–KEN

Check out some great finance blogs through these links:

Budgets are Sexy

Mr Money Mustache

Rock Star Finance

And check out my art: GraphTees

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