Options Trading Tutorial

Covered Call Writing when the stock price is above Strike price?

I want to know if this is legal. If so what are my profits.. I bought 300 shares at $8.00 21Aug08. The call option for 7.50 Sep 08 expiration in .85. So can I sell 3 options for $255. What happens now as stock price is above the strike prices. Will the option is exercised immediately? If so what are chances of gains and loss.. I am assuming stock wont go below $7.3

Public Comments

1. Yes, it is legal to sell in-the-money options. A call is usually exercised early due to dividends. Check if the stock goes ex-dividend between now and Sep expiration, which is on the 19th. If it does then assuming the stock price stays above the strike the call will be exercised the day before the stock goes ex-dividend, in which case you will lose your stock and will not get the dividend. If there's no ex-dividend date then your call, most likely, will not be exercised early. As long as it has some time value you are fairly safe. As you sold the calls at 0.85, your effective stock purchase price is 7.15, and your max profit is 0.35.
2. yes. it's legal it usually exercised at the expiration date.
3. Sure it's legal but it's not the sure thing you think it is. First, the options won't be exercised right away. Why would someone pay .85 and then exercise it right away? They'd simply buy the stock at $8 and save .35. Why would you assume the stock won't go below $7.3? Given the current environment it's very possible. What happens if the stock goes to $6.00? You'd be out $1.15 per share. What happens if the stock goes to $10.00? You've sold your stock at $8.35.
4. In the money calls aren't likely to be assigned - as long as the stock price minus "bid" for the option is less than the strike price, the option owner can more easily (cheaply)take his profit by selling at the "bid" . Assignment is more likely to happen when the option is deeper in the money, and / or closer to expiration. If the stock price falls to 6$, you'll be .85 better off than if you didn't sell the call. and you'd be able to sell another(probably worth .15, front month). If the price jumps to 10$, you could use a "spread" order to simultaneously buy back your call, and sell another for the next month. A 7.5 call would be kind of deep in the money, risk of getting assigned during last week. Now , a 10$ call- It'd cost about 2.6 to buy back, you'd get about .65 premium for sale, but you'd have a 10$ stock and .55 in pocket. Watch out for "up" and "down" expiration days. If a stock is on a rise going into expiration, buying interest will increase, because people don't want to let a good stock get away, because they sold a call - so they'll buy some more shares. after expiration, the price will likely revert. Likewise with put sellers- they're going to get assigned, so they'll sell something. Notice that the middle of each month amplifies whatever trend was there before, then usually reverts. Also - you realise that the "time" value of an option sold decreases faster as it approaches expiration. So an option with 1$ time value at 1 month, will still have perhaps .45 at 1 week, maybe .3 at 1 day? When you sell an option ,you are "holding the risk" in return for a premium. So, my favorites are front week, or even front day options - especially if you figure that the stock price will likely revert, right after.