What Happens When Call Options Expire In The Money Spy

Are you lot thinking of selling monthly covered calls for weekly or monthly income? If so, you came to the correct identify. Of course, if you lot landed here by accident, this article is sure to surprise you.

As of May 2022, selling covered calls is still one of the about bourgeois income trading strategies that investors use to generate additional weekly or monthly income.

Indeed, I like to sell covered calls to generate portfolio income (option premium) – however, the fundamental to being successful is to employ a high probability strategy. And, in this article, I'll go through the procedure that I use, to sell covered calls, with the idea of keeping the unabridged premium.

What Are Covered Calls?

Before getting into selling covered calls, it's of import to know what an option is.

An option is a contract between two people, a buyer, and a seller. The call selection gives the seller the obligation to do something should the buyer asking it. Simple!

What Is A Call Option?

A telephone call option is a contract where the buyer has a right (but not an obligation) to purchase an item (in this case, shares) at a set price, at any time earlier a specific expiration date. The seller has an obligation to sell the detail if the buyer requests it (chosen exercising).

You may have heard nearly selling put options. Put options are the contrary of call options in that they allow the heir-apparent the correct (but not an obligation) to sell shares, at a fix price, at any time earlier a specific expiration date.

For the purpose of this article, nosotros'll be talking near call options.

Starting time, it'south essential to know what a call option is.

What Makes a Telephone call Option "Covered"?

The "covered" portion of the covered phone call simply means that the call option seller already owns at least 100 shares of the underlying equity that he or she is selling the call option on.

How a Selling Covered Calls Works

For example, permit's take Jimmy, Sally, and a pound of beans.

Today, beans are worth $10 a pound.

Jimmy has 100 pounds of beans and wants to sell someone an option to buy his 100 pounds of beans, in one month, for $11 a pound. You encounter, Jimmy thinks the price of beans will exist most the same or lower (next month) than they are today.

On the other manus, Sally thinks the price of a pound of beans will likely go upwardly side by side calendar month.

So, Sally enters into an agreement with Jimmy to purchase his beans at whatever time, up to a month from now, for $eleven a pound. In render, Sally pays Jimmy a fee of $1 a pound for this contract (this is the covered call). The $100 is the income (selection premium) that Jimmy gets to keep, no affair how much the beans become upward or down in value.

Jimmy collects the $100 and agrees to sell Sally his beans next month for $xi a pound, should she make up one's mind.

Related read: Webull vs Robinhood – What to Know well-nigh These Two Brokerages

One month goes by…

Fast forward next month, if a pound beans cost more than than $11, Emerge will purchase the beans from Jimmy for $xi. Otherwise, if the beans toll less than $11, her option contract is worthless. Whatever happens, Jimmy gets to keep his $100 income (selection premium) from Emerge.

Who would you rather be? Jimmy, or Sally?

All options have rights and obligations. For example, those who purchase call options have the right to buy the underlying equity from the seller at any point earlier the expiration date. In exchange, the choice buyer pays the seller an pick premium (income). And, this premium is a guaranteed income that you get to continue. Best notwithstanding, you can repeat the merchandise, over again and again, week after week, month later calendar month.

Things to Know About Selling Covered Calls

Similar whatsoever investment, you'll demand to know some basic things virtually the trade. To be certain, selling covered calls requires a certain amount of understanding of the rights and obligations of both parties.

What practise I need to Sell a Covered Telephone call

To sell a covered call, you first need to own the (underlying) equity. And, because each telephone call option contract is for 100 shares of the underlying equity, you'll need 100 shares x the number of call option contracts you wish to sell.

Suppose you desire to invest 100k. You could showtime past buying the SPY. If you lot want to sell 1 covered call pick on the SPY, you'll need to take 100 shares of the SPY in your brokerage account. Conversely, if you want to sell v covered call options (and earn 5x the premium), you'll need to have 500 shares of the SPY in your brokerage account.

What if I don't have the equities in my brokerage account?

Naked call pick selling is when you sell a covered call, but don't take or want to own the underlying security. And, naked call options theoretically has unlimited take a chance. To be sure, it's beyond the scope of this article.

Covered Call Lingo

When reading about, or discussing covered calls, information technology'due south of import to know what it all ways – especially when information technology comes to generating income!

Strike Toll

The strike price is the contracted price that the buyer can buy the equity from you (stock, or ETF). In the Jimmy and Sally example, $10 is the strike price.

Expiration Date

The expiration date is the final appointment the buyer can buy the equity (called exercising) from you.

Options Premium (Your Income)

The selection premium is the amount of money yous get to collect for selling the covered call.

Related read: 19 Blue Chip Stocks for Incredibly Reliable Dividends

How much can you lot brand selling covered calls?

In general, investors can earn anywhere between i and 5% (or more) selling covered calls. How much you earn depends on how volatile the stock marketplace currently is, the strike price, and the expiration date. In general, the more volatile the markets are, the higher the monthly income yous'll earn from selling covered calls. Conversely, when the markets are calmer, you'll have to sell calls with a further expiration date.

I prefer to sell "out of the money" covered calls with an expiration of about 3-6 weeks out. Indeed, this strategy gives me the near amount of income upfront. Nonetheless, it limits the potential growth of the underlying equity. And, I'm OKAY with that!

Can I Become A Covered Phone call Millionaire?

Selling covered calls is a low-risk strategy for earning weekly or monthly income. More often than not speaking, low-risk strategies on their ain, won't make you a millionaire. If you're looking to become a millionaire, you lot might first look at how to become financially contained.

What Are The Risks in Selling Covered Calls?

The only adventure in selling covered calls is that y'all may lose out on potential profit.

For example, let's say you bought the SPY at $416.58 and sold an at-the-money-covered telephone call with a strike of $417. Doing and so netted a premium of $three.08 (or $308).

And then, at expiration, the SPY trades at $419. In this case, y'all'll have lost out on $2 of profit. Simply, don't forget, you'll already take nerveless $3.08 (times 100) for the telephone call option itself!

Getting called isn't necessarily a bad thing. What'southward important is that in the end, yous'll have made a profit.

Revenue enhancement risk

If you take owned the underlying stock for a long time, you might have a significant capital gain, and if your option is exercised, that gain will exist crystallized.  Is information technology a big deal?

Suppose you've owned Abbot Labs since 2016 when information technology was trading around $40.  If you had to sell your stocks in May 2022, y'all'd potentially take thousands of dollars of uppercase gains to deal with at revenue enhancement time, for each call option contract sold.   And depending on your tax rate, this could result in a significant tax brunt.

For that reason, ever keep a taxation preparer on speed punch.

Examples of Selling Covered Calls

Allow's consider an example of selling covered calls to generate some income.

Suppose that equally of today, May 29, 2022, the SPY is trading at $416.58. The $417 call option expiring June 29 is currently being bought for $4.08.

What does this mean? If yous own 100 shares of SPY, y'all can sell ane covered phone call option, and generate $408 in income, that's yours to keep no affair what happens to the price of the SPY! Best yet, with selling covered calls, if you desire more guaranteed income, you can sell more 1 contract.

Related read: Stocks Vs. Options – What'southward Right for You?

Selling Covered Calls: Scenario #1

Suppose today, May 29, 2022, the SPY Trades at $416.58

You purchase 100 shares of the SPY for a total outlay of $41658.00

Then, you sell ane covered call contract, out of the coin ($417 strike) that expires June 29, for $408

Right off the bat, you've earned $408 from the covered call. Indeed, that's covered call income y'all go to go along.

On June 29, if the SPY trades at $419, your contract will be exercised. Yes, you'll take to sell your shares for $417. Is this bad? Well, consider that yous bought the SPY for $416.58, and you lot sell it for $417 and collect another $408 in income. So, you lot've lost out on some upside, but the income (option premium) is yours to keep!

Crunching the numbers

However, consider that the SPY is above $417 on June 29, and you sold your SPY disinterestedness for $417. In this case, you lot'll have a turn a profit of $32 ( $417 – $416.68 = $0.42 times 100) on the SPY, and you yet keep your $408, for a total profit of $440. Indeed, that a significant rate of return in only two weeks! How cool is that?

Selling Covered Calls: Scenario #2

Using the same SPY from scenario #ane, you buy 100 shares of the SPY for a total outlay of $41658.00

Then, you sell ane covered telephone call contract, out of the money ($417 strike) that expires June 29, for $408

And like before, you've earned $408 from the covered call. Indeed, that'southward the covered call income you get to proceed. Also, don't forget, information technology lowers your cost to buy the SPY past $408.

Then, on June 29, if the SPY trades lower, at $415. Annotation that this is lower than the strike toll on your covered call. Too, it's lower than what y'all paid for the SPY. Your call option contract expires worthless, and y'all get to keep your shares.

In this case, you get to keep your SPY, and the covered call expires worthless.

Crunching the numbers

Yous initially bought 100 of the SPY for -$41658.00

You lot received $408 in call option income (AKA Premium)

The value of the SPY shares on June 29, is now $41500.00

Your annualized rate of return is now 15.463%. Considering over the past 90 years, the annualized rate of return of the S&P 500 is 9.viii%. So, I think xv.463% is a winner!

But, here's where information technology gets interesting. In this example, your call selection expired worthless, and let's assume that in this scenario, you kept the shares. And so, yous can start selling another weekly or monthly call selection, and that income is also yours to keep. Rinse and echo!

How to Detect Covered Calls Worth Selling

The goal of every call option seller is to let the selection elapse worthless. If you're looking for the best chances of having an option elapse worthless, I use an options scanner to browse the marketplace for different options.  Let'southward accept Abbot Labs equally an example.  To browse for options, I tin open my Options Samurai account, and start by clicking "compose new browse".

So, I'll input in the stock, ABT, remove the option volume, remove expiration, remove moneyness, remove return – merely I'll continue annualized return, add open up involvement, and ready the probability of expiring worthless to 90%.  This means any call options that come up in the results will accept at to the lowest degree a 90% chance of expiring worthless.  So, I hit "run browse" to meet the results.

And in the above example, you tin see the Abbot Labs $123 strike is selling for around $.16 or 16 per contract expiring Oct 2 – in just 2 days.  The annualized return is fourteen.44% and there's open interest, meaning there are currently people with orders ready to purchase this option at this price. And best of all, there's a more than ninety% take chances the selection will elapse worthless. Non bad!

How Practice We Price Call Options?

Invessotrs toll call options are on their intrinsic value (The difference between the strike cost and the underlying equity), and fourth dimension value – which is the rest of the value.  Both "time to death" and "volatility" influence the fourth dimension value heavily. Putting information technology differently, Investors will make the near coin selling call options on dividend stocks with longer expiration dates, when volatility is high.  If volatility is low, and the expiration is sooner, the pick premium will be less.

Tin can I Sell Covered Calls on Dividend Stocks

Dividend stocks are shares in companies that pay a dividend.  Many companies pay dividends, such every bit blue chip stocks on the coveted dividend aristocrats and the dividend kings lists.

Generally, copmany pay dividends from their net profits, merely, it'southward more of a best practice than a rule.  Also, companies often pay dividends quarterly. Still, some dividend companies also pay monthly, semi-annually, or annually.  The dividend amounts are often the aforementioned, or greater each flow. Still, when times are tough, companies volition often cutting their dividend.  The nice matter about selling covered calls is that no matter what happens to the dividend, yous'll nevertheless be able to sell the choice.

When Selling covered calls, who keeps the dividend?

At present, you lot might be wondering about the dividend.  First, if the company pays a dividend, the choice will already gene it in to the price.  Suppose we have Abbot Labs again equally an example. Say you sell a covered call option on information technology. And, a dividend gets paid between now and the options' expiration. The dividend amount volition already exist part of the option toll when you sell information technology.  So yous get to go along the dividend AND the telephone call selection – and many investors make two even three or more than times their income by using this strategy.  Double-dipping is the colloquial term.

Is selling covered calls profitable?

Selling covered calls is a guaranteed fashion to earn weekly monthly income, and aye, it tin can exist very profitable. The key is to recall to buy high-quality equities or ETFs. My favorite equities for selling covered calls on are the SPY (SPDR S&P500 ETF), and large, quality companies such equally Apple tree and Google. Indeed, over the long term, these are high-quality companies whose stock prices generally move upwards.

Notwithstanding, you should have a programme B in example your disinterestedness loses value. In the SPY scenario higher up, if it dropped to $410 or $400 at the time of expiration, what could yous do? Well, you could write another telephone call option. Or, purchase more of the SPY to lower your boilerplate cost and write more options, or you could take the loss (never fun) and move on to something else.

Can You lot Lose Money Selling Covered Calls?

You volition never lose money by collecting the income from selling the covered call. To be sure, the income you receive from selling covered calls is yours to keep. However, if the equity loses value (i.due east., the SPY drops below the purchase price), AND you sell information technology at a loss, so aye, that could incur a loss. And so, but like having a home budget where you rail your income and expenses, information technology's essential to keep track of your profit and loss on your covered call strategy.

Computing the returns

If you're a numbers guy, like I am, you'll probably want to calculate your almanac rate of returns on covered telephone call selling. Then, here's how you practice it.

There are two returns y'all'll probably want to know. The get-go is the total return.  And the other is the annualized return.  The total render is the amount of the income, divided past the stock price.  Allow's say you got 72 cents for selling the call option on ABBT (Trading at $118), and the option expired worthless, your total render is around 0.6%.

Now, 0.half-dozen% might not sound fun, but what if that was just after a week, or a calendar month?

If you sell a telephone call choice that expires worthless in 15 days,  the annualized render would exist:  (option income x 365 days x 100) / (stock price x weeks left for telephone call option expiration)

(.72* 365 * 100) / (118.00 * fifteen)  = fourteen.85%

14.85% is far more than interesting than 0.half dozen%, isn't it?

Bonus: What is a poor man'due south covered call?

Yous may similar the idea of selling covered calls, simply don't take or want to buy 100 shares of the stock or ETF. If so, consider the Poor Human being'southward Covered Telephone call. To be sure, it's as well known equally a credit spread or a covered telephone call spread.

A poor man'southward covered call has two variations. As above, when you sell a covered phone call, the call selection is covered past the underlying stocks and ETFs that you lot already own. With a poor man'due south covered call, you don't actually demand to own the stock! Rather, you lot'll need to replace the stock with something else. Here are the two variations:

A variation on a Poor Man's Covered Phone call #1: The Vertical Spread

With a vertical spread, you sell a slightly out of the money call option, so buy a further out of the money call option.

Suppose nosotros borrow from the same example as above, today, the SPY is trading at $416.58.

The June 29 $417 call option is selling for $4.08.

The June 29 $420 phone call choice is selling for $3.fifty

In this case, if you don't own or want to own $41,658 ($416.58 * 100) of the SPY, then you could sell the June 29 $417 SPY call option for a full of $408. And, at the same time, you tin can buy the $420 phone call for $350, leaving you $58. The call choice that you bought becomes the covered portion.

WARNING: There is a adventure with a this scenario. The risk is if the SPY trades above $417, you'll have to sell 100 shares of the SPY at $417. However, your risk is express. It is the difference between the option strike you lot sold, and the option yous bought, minus the premium received.

So in this case, the risk is $242 and we calculate it equally follows: (($420 – $417) – $0.58 ) * 100 = $242 . As a result, y'all'll want to consider selling this type of strategy further out of the money to avert surprises.

Variation #2: Using Leaps In a Covered Call Strategy

With variation #2, you lot can sell a poor homo'southward covered call by ownership an in the coin LEAPS option , equally far out as possible. A LEAPS option is similar a traditional option, only that information technology has a much longer expiration. At the time of this writing, LEAPS on the SPY get equally far out as two and a half years.

If nosotros borrow from the same example as above, today, the SPY is trading at $416.58.

The SPY June 29 $417 call option is selling for $iv.08.

The SPY June 29, 2024 $290 telephone call option is selling for $152.49

In this case, you tin buy the SPY June 29, 2024 $290 option for $fifteen,249. And you lot can agree it until expiration. We are buying the $290 because the further in the coin information technology is, the college the delta will be. In other words, it will be better correlated to the actual market prices.

And so, you can start selling covered calls (out of the money). If yous go exercised, not to worry, your LEAPS option will have gone up (near) proportionately. If the SPY goes down, again, you keep the income from selling covered calls.

Oftentimes Asked Question (FAQ)

Are covered calls bad?

The but thing that is bad about covered calls is that you lose any potential upside over and above the strike price. However, yous do collect the income as a result.

What is a poor homo's covered call?

A poor human being'due south covered call is also known as a credit spread. In this case, the "poor human" either doesn't have the funds to purchase the 100 shares of the equity, or merely doesn't want to buy the equity. In this case, the "poor homo" sells his covered phone call and and then buys one at a strike toll slightly further out of the money (for less than the call he sold). The "poor man" gets to keep the difference, known as the credit. The chance is the deviation betwixt the strike prices. A credit spread (or poor man's covered call) is a riskier transaction but requires less money upfront, and one for another commodity.

Should you sell covered calls?

Anyone seeking boosted income from their portfolio should consider selling covered calls.

How practise you sell calls for income?

At a minimum, you volition demand a brokerage business relationship, with options trading (Y'all might demand to permit the brokerage know you desire to sell covered calls).

What happens when you lot sell a covered call?

Every bit shortly as you sell your covered telephone call, the income (option premium)gets deposited into your brokerage account. Mostly speaking, y'all can do whatever you lot want with information technology.

What about selling weekly covered calls?

You tin sell weekly covered calls, notwithstanding, just be aware that y'all will collect more income, the further into the future you sell the call.

What are the best stocks for covered calls?

In my stance, selling covered calls on loftier-quality stocks and index ETFs gives you the all-time consistent return.

Are covered calls safe?

Most agree that of all choice strategies, selling covered calls is among the safest strategies out at that place. Selling covered calls is a prophylactic strategy because you already own the equity, and the monthly income (premium) you earn lowers the bodily cost of ownership.

What is the Best Strategy for Selling Covered Calls To Generate Income

The aim of this website isn't to provide investment advice; instead, information technology gives you the tools and cognition to go financially independent.

Can you lose coin selling covered calls?

Traders who sell covered calls always get to go on the income. However, a loss can occur if the stocks, ETFs, or Futures contract is assigned at a loss.

Conclusion

Selling covered calls can be an splendid way to generate monthly income. To exist sure, any investment incurs a lilliputian take a chance, and I feel that past selling a covered telephone call, you are reducing your overall gamble.

*Disclosure: On the date of publication,Rick Orford did not have (either straight or indirectly) any positions in whatever of the securities mentioned in this article.  All information and information in this commodity is solely for informational purposes. The information herein is based solely on my personal opinion and experience. All investments hold inherent adventure, and the information provided should not be interpreted equally any kind of guidance, recommendation, offer, communication, or suggestion. Any ideas and strategies discussed on this channel should non be implemented without first considering your financial and personal circumstances or without consulting a financial professional.

Source: https://rickorford.com/selling-covered-calls-for-monthly-income/

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