When you write a call, you receive cash up
front and, in most cases, hope that the option is never exercised. It can be conservative or
risky, depending on whether you’re covered or uncovered.
You might write calls in order to receive short-term income from the premium you’ll be paid. If that’s your strategy, you anticipate that the option you write will expire out-of-the-money, and won’t be exercised.
In that case, you’ll retain all of the premium as profit. If you’ve written this call on stocks you already own, known as a covered call, the premium can act as a virtual dividend that you receive on your assets. Many investors use this strategy as a way to earn additional income on non dividend-paying stocks.
Alternately, you may view the premium as a way to reduce your cost basis, or the amount that you paid for each share of stock.
Writing covered calls is a popular options strategy. If you buy shares at the same time that you write calls on them, the transaction is known as a buy-write. If you write calls on shares you already hold, it is sometimes called an overwrite. This strategy combines the characteristics of stock ownership and options trading, and each aspect provides some risk protection for the other. If you write a covered call, you retain your shareholder rights, which means you’ll receive dividends and be able to vote on the company’s direction.
Writing covered calls is a way to receive additional income from stocks you already own. It can also offer limited downside protection against unrealized gains on stocks you’ve held for some time, since you lock in a price at which to sell the stock, should the option be exercised. You should bear in mind, however, that if a stock on which you’ve written a covered call rises in value, there’s a very real chance that your option will be exercised, and you’ll have to turn over your shares, missing out on potential gains above the strike price of your option.
In order to calculate the return on a written call, you’ll have to take into account the transaction costs and brokerage fees you pay for opening the position, which will be deducted from the premium you receive. And if your option is exercised, you’ll have to pay another round of fees. But since you probably plan for your option to expire unexercised, if you’re successful you won’t face any exit transaction fees or commission. If you write a call on stock you hold in a margin account, you should consider the margin requirement imposed by your firm when calculating return. If your trade is successful you retain all of your capital, but it will be tied up in the margin account until expiration. That means you can’t invest it elsewhere in the meantime.
Exiting and Exercise
If the stock or other equity on which you wrote a call begins to move in the opposite direction from what you anticipated, you can close out your position by buying a call in the same series as the one you sold. The premium you pay may be more or less than the premium you received, depending on the call’s intrinsic value and the time left until expiration, among other factors. You can also close out your position and then write new calls with a later expiration, a strategy known as rolling out. If the call you wrote is exercised—as is possible at any point before expiration— you will have to deliver the underlying security to your broker. The assignment for an exercised call is made by OCC to any of its member brokers. If your broker receives an assignment on an options series on which you hold a short position, you may be selected to fulfil the terms of the contract if you were the first at your broker to open the position, or by random selection, depending on the policy of the firm. It is extremely rare for the writer of an in-the-money call to not have to sell the underlying stock at expiration.
If you choose this strategy, you’ll have to keep the minimum cash margin requirement in your margin account, to cover the possibly steep losses you face if the option is exercised. If you are assigned, you must purchase the underlying stock in order to deliver it and fulfil your obligation under the contract.
Source: The Options Industry Council otherwise known as OIC