Just saw this today. The OP probably forgot they made this post and may be long gone by now, but thought I'd chime in in case anyone is wondering.
I am by no means in expert an options but I will tell you what I know. The scenario the OP stated is correct. It may very well sound too good to be true. But the fact the it deals with options is enough to scare many traders away when in reality, using this strategy is an excellent method for an addition source of income. This is called a "covered call". "Covered" because you own the underlying stock and therefore have limited risk. This is a strategy mainly used for people who buy and hold, and thus will keep the stock regardless of minor price fluctuations.
The one thing I will say regarding the OP's scenario: With this strategy, your main goal is for the option to expire worthless. I would advise against selling options that expire really far in the future. Option value decreases faster as expiration comes closer. So selling options no more than 1-3 months away from expiration would be in your best interest.
The benefit: Additional income from a stock that is otherwise sitting in your portfolio doing nothing. One profits from Covered Calls if the stock goes up, stays flat, or even goes down a little.
The downsides: Should the stock run up while you have sold calls on it, you will have limited upside potential. *This is key.* The last couple times I have written options for a stock I owned, the stocks made a substantial increase and I ended up buying back the options I had sold for more than I received. I would have made more money had I never written the calls. Therefore, don't sell options on a stock you think will make a big jump unless the options are WAY out of the money. Also, commissions for options are higher, thus eating into your profits quicker.
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I will use a real world scenario to illustrate this. Currently, the stock SVNT is trading at $5.30. Say I wanted to buy (or already owned) 100 shares worth $530. Looking at the option chain, I see the JUN 7.50 calls selling for about $1.10. These expire in 32 days. I can sell one of these calls and receive $110 in my account immediately. My total risk for this stock would now be $420. ($530 for the stock - $110 for the option = $420) The stock can now fall and you'll still be in the green.
Scenario 1: Stock goes down a little. If the stock is trading at $4.70 in 32 days, the option will expire worthless. While youre profit on the stock is down $60, the income from the option would offset this and you would actually be up $50. Not ideal, but still not bad considering the stock actually went down in price.
Scenario 2: Stock stays the same. If the stock is trading around $5.30 still in 32 days, the option will also expire worthless and you will most likely not get called out (have the stock bought out from you. No one would want to buy the stock from you at $7.50 when it's trading in the open market at $5.30.)
Scenario 3: *Best Scenario* The stock goes up a little. Say the stock is trading at $7.30 in 32 days. The option would expire worthless, and you would still most likely not be called out. You can turn around and sell the stock you bought for $530 for $730, and you made $110 from the option. Giving you a cool 60% profit or $310 in 32 days. (I think I did that math right.
) *Before commissions, of course.*
Scenario 4: *Not Ideal* The stock skyrockets while you have sold calls on it. Say in 32 days, the stock has jumped to $15.00. Had you not sold the call, you would've turned $530 into $1500. Mmmmm...
However, you did. This option DOES NOT expire worthless. Although, because we're assuming you never bought it back, you still get to keep your initial $110. This time you most likely WILL get called out. Someone out there has the right to buy your stock that is worth $15.00 per share for only $7.50 a share. For this, you will receive $750. You still made $330, not bad. ($750 + $110- $530 = $330) However, had you never sold the option, you would have made almost $1000.
Remember, all these numbers are based on using a 100 share/1 contract position worth only $500. Carry the decimal point over one on all the numbers for a 1000 share/10 contract position worth $5000. :D
In summary:
- Covered calls are a strategy best used in neutral-slightly bullish markets when the stock won't move very far in either direction.
- While opportunities for profit are more likely--stock can move down a little, stay the same, up a little, or up a lot and you'll still make money--selling covered calls also limits your upside potential.
- As an option writer/seller (as opposed to option buyer) your best friend is time decay. Options time value decrease at the fastest rate in the last 3 months. Selling options with no more than 3 months left would be in your best interest.
- Higher commissions for options. Round trip, the act of buying and selling an option, will be at least $30 at most brokers. If you don't stand to make at least twice to three times that much, it's probably best to avoid it.
I hope that helped at least
someone. Any more questions just ask as I know this may seem rather convoluted, they are a great tool though and it never hurts to learn more about all aspects of the stock market.
New to options, looking for confirmation
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