No. of Recommendations: 10
(1) I know that Jim says this will never happen, but if the stock gets called away will my broker just withdraw the shares from my account?
Yes. Nothing for you to do. The stock disappears, the money equal to the strike price appears.
At my broker (IB), there is no fee for this. I don't know if that's true for all brokers.
(2) Is it better to use a strike price closer to the current price or is the selection of the best strike price just driven by the option premium?
The best way to think of this is to remember that there are two possible outcomes, expiry or assignment, and you don't know which you will get. The buyer of the option gets the option...hence the name!
Whenever writing any option, a good general starting point is to pick one that you're equally happy with both outcomes.
(because, sure as shootin', you'll get whichever one looks worse to Mr Market on the day he decides)
The strike price you pick determines
- the probability that you will get one outcome versus the other. Obviously a higher strike OTM call option is less likely to get exercised the higher the strike, so the more likely you'll get to keep the premium
- the higher strike ones have smaller premiums. Not as much money to keep if it expires.
I tend to pick options that are relatively close to the current price. The premium is a LOT higher, and I'm not scared of the stock getting called away. Don't be.
Remember, I will be "forced" to sell it at a very good price (which I have calculated in advance, strike+premium), and I can always buy the stock back on the open market then if I like. Or on the next dip.
Since I'm getting a big premium, there's a good chance that even an exercised option will leave me in a nice profit position, if the stock price ends up between the strike and strike+premium.
(3) (Related to the strike price question in (2))If the stock price declines - say BRKB drops to $370 - would you be better off having used the higher strike price? $370 is $15 below the $385 strike but $30 below the $400.
In the event that the stock price declines, all that really matters is that you want to have made a lot of money, so you would want to be owning an option that was at the money and long dated. (out of the money by zero = the stock price) That's simply because you'd have received a really big time premium which you will get to keep if the stock price falls and stays lower.
The *amount* by which the stock is lower than the strike doesn't really matter in any other way, in the case that the price is in fact lower and stays there. A lower strike does presumably have a greater chance that the stock will rise back up and beyond the strike if you don't close the position during the dip.
For anybody trying these things, don't get too scared. There is a market for them. You can buy the option back to close the position any time you like. If the stock soars, your option will go into a mark-to-market loss but (a) remember the stock you own is going up! and (b) you're still making a bit of money each day as the time value evaporates. If the stock is called away, you can buy the stock back if you like.
I am not a big believer in covered calls as an "all the time" thing, because it makes no sense when a stock is cheap or fairly valued--writing a call on top of an existing position is a fundamentally bearish move, though not necessarily VERY bearish. When the valuation level is getting a bit rich, I think it makes some sense. In effect, I know I would sell some stock if the price went up to X. Some folks are willing to pay me in advance, pretty well, to commit to doing what I would do anyway.
Jim
