Options for Series 7 Lesson - Long Stock and Short Options ( Covered Calls )

One of the areas in the options section of the Series 7 test are strategies involving Long Stock positions with writing or selling call options. This is called  Writing Covered Calls

Options themselves are risky, but writing calls on the same stock that is owned is considered the most conservative of options strategies. So, if you are taking the Series 7 exam, Series 4 or other FINRA test that will ask options questions, try to be mindful that if you own the stock on the call you are writing, your risk on the option side will be low. But if the stock falls to the floor, the option is not going to help you much, except the premium you got.

Reason for Selling or shorting calls with stock

Income is the #1 reason. Income from the premium received, since you are selling the option. You anticipate the stock to be relatively stable or perhaps rise a little or even go down some. The premium on the call offers you a lower breakeven on the stock position because of the premium received.

Example:  Buy 100 shares of TRS at $50 and Write 1 TRS Feb 55 Call for $300.

No one can read an investor or traders mind exactly, but on the Series 7 Test, you will be asked what the maximum gain, loss, breakeven and a scenario "stock rises to X and the call is exercised or stock falls and the call expires etc.

It all comes down to common sense and assuming you know what the obligation is when you sell or write Options.  when you write a call option, you receive money (premium), but you are obligated to deliver (sell) 100 shares of the stock at the strike price. 

If you own the stock, the loss liability is limited. In the example above, you already own the stock - and at a lower price than the strike price. You have some profit risk because if the stock rises to 70 or something crazy, the call will most certainly be exercised, and you will be forced to sell at 55. Any situation where the stock rises and the call is exercised, you will have realized your maximum gain. In ANY case THE MAXIMUM GAIN IS: $500 on the stock (difference from share price and strike price and $300 (premium received) = $800

Break even on Covered Calls

Series 7 option questions or if you are a novice options trader, Break-even on covered calls with stock is always COST. Price of stock less premium received. BREAKEVEN HERE IS: 47  Always focus on the stock when figuring out losses, gains and break even. You need to answer these questions differently than if they were single contracts where you are taught to add the premium to the strike price on calls. THE STOCK IS THE BIG PICTURE ALWAYS. The option is there for income.

Maximum loss on Stock and selling calls

When options are sold or written, they are for income and to lower break-even. They are not there to protect the stock declining beyond the break-even. If you owned this position, you are good to 47, but any lower than 47 - it's ALL exposed.  So the maximum loss is the same as the breakeven - in real dollars = $4700

Good luck on the Series 7 or any exam you are studying for.

Any questions or comments, feel free to leave. Spam or links to unrelated content will not be published, so don't waste your time :)  This to help people who are studying for the exam.

Nick Hunter
American Investment Training
www.aitraining.com