Covered call buy write strategies

[Oldedit]

Almost all the books I've read about covered call buy write strategies insist that you sell calls with strikes below the price of the underlying stock.

Thus, if xyz is 28 and the July 30 call is 0.90, you buy 100 xyz at 28 and sell 1 July 30 call for 0.90. Your debit is 28-.90=27.10.The Bible of Options Strategies by Guy Cohen calls this a bullish to neutral strategy.

A couple of weeks ago, I signed up for a trial subscription to an advisory service. All of its trades have broken the rules I see in most books. Its trades all involve in the money calls, which means the calls can be called at any time, especially in the last two weeks.

One trade: xyz is at 52. July 50 calls at $3.20. Thus, time premium=$1.20. Breakeven is 52-3.20=$48.80, or a 6.2% drop for the underlying stock.

Why would someone do this trade?

1. Pretty high monthly and annualize yields, if things go right.
2. Tax losses if stock price drops.
3. Wants to have stock called away for some reason?
4. Wants to grab you as a subscriber, making you dependent on the service for trade recommendations and advice on exits?
5. Wants to sell you more advisory services?

Am I too cynical? Ideas?

[netwrangler]

The way I see it, the main reason that in-the-money calls are not usually exercised early is that the owner of the call could simply sell the call, buy the stock on the open market, and pocket the time-value of the option.

Well, there are reasons to exercise early. If the call owner feels the stock is currently at a top and feels the stock is fairly priced at the call strike price, the call owner could decide to exercise and write a covered call of his/her own. Generally, however, I have not had a call assigned more that a couple of days before the expiry -- and everytime when there was a possible arbitrage play at the end.

As to the question, "Why would someone do this trade?" I do trades like that for downside protection -- especially when I am happy with the return from the call premium and don't really care if I keep the stock for another month.

As for the tax implications, the loss on the stock is offset by the intrinsic value of the option. If you get assigned, you end up recognizing a gain for the time value of the option.

At least that's the way I figure it. I'd be happy to hear divergent views. uhh...Concurring views would be OK too. <grin>

[netwrangler]

Why would someone write an in-the-money covered call?

If the price of the stock is in between strike prices, you have to make a choice. For example, if stock abc is selling for $92.50/share, you have at least two choices:
sell a 95 call and hope the stock price goes up
sell a 90 call and enjoy some price protection


It usually doesn't make economic sense for a call owner to exercise early. Usually, the owner is better off to
sell the call
buy the stock on the open market
pocket the time value of the call

Early exercise does happen, especially near expiry, but it isn't as likely as one might think.

But, exit strategies, now there's an interesting topic. When do you bail on a covered call? And how do you do that mechanically -- especially if your broker wants you to buy back the call before selling the stock [no naked calls]? I'd love to hear thoughts about that.