Yesterday, I began a discussion of commonly-espoused thoughts about options that just aren't true. Today I'll deal with the second idea that comes up often.
Those who believe the preceding statement tell us that when options expire you have made money for nothing. You'll keep your shares while pocketing 100% of the call premium. After expiration, the obligation to deliver your shares is extinguished.
They are right about getting something for nothing, but not in the assertion about that being your best-case scenario.
To understand where they go wrong, you need to look at a real-life example. I'm using Xilinx (XLNX) as an example, but it would be the same principle with any stock.
Covered calls can only be sold on round lots (100 share multiples) of stock held in the same brokerage account. In this example well assume we just purchased 100 XLNX at the $41.22 asking price.
The net outlay would have been $4,122 plus commission.
The last actual trade on the sale of XLNX's March 2015 $45 strike price call fell between the bid-ask spread at $1.29 per share.
A seller of one March 2015 $45 covered call at $1.29 per share would receive $129 less commission. That would reduce the net risk of the position by $128, assuming $1 in trading expense.
Let's see how the position would look if Xilinx remains unchanged on the March 20, 2015, expiration date vs. how it will play out if the stock rises moderately or to anywhere above $45.
Are you better off if the option expires or if it is exercised?
People who love expirations focus on the times when the underlying shares go well above the strike price selected. If XLNX has good news, or a takeover pushes the stock to $50-$60 or higher, you will be sorry you sold that call option. But you will still be better off than if the option had expired worthless.
The absolute maximum liquidation value on expiration date for an expired $45 call would be $4,499 plus the call premium received. By definition, any exercised $45 call option will beat that number.
Once a covered call is sold, your best profit comes if an exercise takes place.
Myth No. 2 busted.