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I am new to options.

I have a long position in unrealized loss, which I believe will eventually return to break-even, but I do not know when.

It is my intention to make sure I close the position without a loss, while extracting some liquidity out of it at present. For that reason, I am considering selling covered calls for my position at my break-even.

My concern, due to exercise being under the option holder's control, is that I may miss out on a spike that would normally have me close the position at break-even, with the price soon dropping back under my break-even and never rising again before expiration (i.e., pocketing the premium, but back to square one).

Is this a valid concern? Do I understand it correctly that it could easily happen that I miss out on a spike and remain stuck in my unrealized loss because the option holder does not elect to exercise at the time, and even if they sell the calls at a profit, the new option holder's calls may later expire worthless, with my position unchanged despite the spike?

I am asking specifically about spikes, because

  • I understand that if the price stays up until expiration then I will certainly be out of my position one way or another; and
  • spikes may happen for brief periods and outside of RTH, and the price wouldn't likely be maintained until expiration.
user162450
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3 Answers3

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Yes, when you sell a covered call you give up potential upside in exchange for immediate income (the premium). You also keep downside risk - if the stock tanks, your call will not be executed but your covered position will lose value. It's called "covered" since if it is exercised, you already own the stock; you don't have to buy it to cover the short call.

A covered call does NOT guarantee that you can "close the position without a loss". You'll need to put in a stop-loss order or buy puts to remove downside risk. Selling a covered call just changes your break-even point so you can have a lower stop-loss if you want to guarantee no overall loss.

If the stock spikes, your option and stock positions will largely cancel out. The option will become more valuable (a loss to you) but will be offset by an increase in the stock value. You could, of course, buy to close the short option and sell the stock to close out your overall position.

Early exercise (e.g. during a spike) is also unlikely since it's generally more profitable to sell an option than to exercise it early. If you did get exercised early, it would probably be better for you than buying to close the option.

Example - suppose you sold calls at 100 for a stock that was now trading at 120. The option would have at least the intrinsic value of 20 - suppose it's trading at 25. It would be better to have the option exercised and "lose" 20 (if you wanted to buy back the stock at 120) than to buy to close the option at 25. It would be more likely that the holder would sell the option for 25 than to exercise at 100 for a profit of 20.

D Stanley
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You should consider the long stock and short call as a combined position or strategy. It is equivalent to simply a short put.

There is no reason the option strike needs to be the price at which you originally purchased the stock. You can choose a strike that gives your desired risk/reward.

Separately, if your goal is to liquidate the stock if and when it reaches your purchase price, you could use a conditional order to close both the long stock and the short call based on the stock price reaching a target.

You should check with your broker and make sure you use an order type that guarantees the stock is not sold without also buying the call to close. You don't want to risk having a naked short call. Ideally the order will be to close the whole strategy as one trade, and it could even be like a limit order based on getting the desired overall price for the strategy.

Even simpler, instead of selling a call, you could sell the stock now and then sell a put secured by the cash proceeds. This would amount to the same thing, and you could use a straightforward limit order to close the put if its price goes down enough (corresponding to the stock price recovering).

nanoman
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There're two kinds of options - one that can be exercised at any time ("American style options") and one that can only be exercised at expiry ("European style options").

It sounds like you're dealing with American style options, since you're thinking of there being a spike in the price and the option-holder exercising the call.

Is this a valid concern? Do I understand it correctly that it could easily happen that I miss out on a spike and remain stuck in my unrealized loss because the option holder does not elect to exercise at the time, and even if they sell the calls at a profit, the new option holder's calls may later expire worthless, with my position unchanged despite the spike?

Yes. Whoever bought your call option might elect not to exercise it, even though they could for a profit. (The obvious reason is that they think the price will go up even more, in which case the call will be worth even more if they don't exercise it.) They could also resell the call, in which case there is a new option owner, and the new option owner might also choose not to exercise it.

If the price drops, then yes, the calls might expire worthless in which case nothing happens to your underlying position.

Allure
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