I'd have to buy 100 shares to write a call per Robinhood collateral requirement. If the option expires ootm, I'm stuck with 100 shares of less valuable stock, which offsets the credit. This is stupid. Am I missing something?
Posted Oct 29, 2018, 4:46 PM UTC
You can cover a call option with shares of the underlying stock, cash, or another call option you purchase for the same stock.
Edit to clarify and give an example.
I mention cash as an option for covering your call, but it is not used alone. Cash can be used in combination with another call option that you purchase.
For a quick example, you buy a $20 Call for $1.85. You sell a $16 Call for $5.35. You get a $350 credit from the premium, $535 from the sale minus $185 from the buy. Robinhood takes $400 cash as collateral to cover the difference in share value from $20 to $16.
You risk $400 to gain $350. If the price of the underlying stock stays below $16 at expiration, and you don't get exercised OTM, you get the $350 premium at expiration and your $400 cash collateral back.
Definitely do some research before you start writing Options. There is a lot to them.
How is calculating pop done for a credit spread like that? I can definitely see why my thinking was naive. I had tunnel vision on the pop of the written call and didn't think it through.
Thanks for your help.
From the example, if the stock price is below $16 on expiration you pocket $350 (the premium from the sale).
If the stock price is $20 or higher on expiration, you lose your full cash collateral a $400.
If the stock price falls between $16 and $20 on expiration, you lose the difference between the stock price and $16. If the stock price ends up at $16.50, you lose $50 of your cash collateral. if the stock price ends up at $19.99, you lose $399 of your cash collateral.
Having two options in the mix can make it a little confusing. Try thinking of it like you don't have the $20 call, you only sold a $16 call.
If the stock ends up below $16, your profit is the premium from selling the call option.
If the stock ends up at $16 or above, you have to sell stock at $16 a share. Your loss is the difference between $16 and whatever this price of the stock is that you have to buy at.
In order to sell stock to your buyer, you have to buy it. If stock cost $16.50 on that day, you would be paying $0.50 a share over what you were getting paid by the buyer, resulting in a $50 loss.
If the stock cost $19.99 on that day, you would be paying $3.99 per share over what you were getting paid by the buyer, resulting in a $399 loss.
If the stock cost $25 on that day, you would be paying $9 per share over what you were getting paid by the buyer, resulting in a $900 loss. You would have a call though so you would be locked into a price of $20 and a max loss of $4 per share when you buy the stock at $20 to sell to your buyer for $16.
The only thing that buying a call for yourself does is put a max price on what you will have to pay when you buy that stock to cover the call you wrote on expiration. That is the only difference it makes.
The call you buy is just insurance for yourself, a limit to your risk. If the stock price went to $500 by expiration, you would be on the hook for $484 per share, or $48,400 total. Not a good situation and the reason why Robinhood will not let you use just cash as collateral. Both you and they do not know what the potential stock price will be. We can all make really intelligent guesses, at least limiting it to a reasonable range, but we don't know for sure and just about anything can happen.
You might get some benefit from checking out http://www.optionsprofitcalculator.com/
In this specific instance, you would want to use their Call Spread Calculator.
I've used that site before to dabble, and I understand how credit spreads can play out, but is it possible to calculate probability of profit on a multi-leg trade, similar to just buying or writing an option?
Thanks for the explanation.
The whole idea of owning the underlying asset is that if the stock goes up and the option gets assigned, you're not selling the 100 shares at the spot price, but whatever price you originally paid for it. If you're just using cash as collateral then you're spending more $ to fill that exercised option since you'll have to pay the spot price of the stock rather than the price when you initiated the contract
Ah, covered calls. One of the most underrated option strategies out there.
Buy 100 shares of SPY. Sell any otm call option. If SPY stays below that strike price, then you keep the entire premium which reduces your cost basis. If you do this long enough, you can eventually reduce your cost basis to 0.
If SPY rallies above that strike price, then you sell your 100 shares at that strike price and you also keep the premium. You miss out on the rally above the strike price, but who cares! Just do it over and over again.
Not for speculators, though. But later on, you’ll start to appreciate this strategy :)
You can use cash as collateral instead, but it'll be locked away until you're out of that option.
That's kind of the point of a covered call. If the price drops you get the premium to offset it. It's about limiting downside risk, not making tons of money.