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Author: joelcorley Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 1207  
Subject: Re: Covered calls Date: 11/30/2004 4:31 PM
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tnvjeff,

You wrote, I understand the idea of selling the covered call but what happens when or if one decideds to close the position before expiration. Do you have to give back the money that you originally got for the option?

No, you don't give back the money. Instead you buy a call to close the open position -- writing a call opened that position. The cost of that call may be more or less than the call you sold.

Also, If so then it appears to me that that the covered call seller would want the price of the option to go down and not up or you would lose more money?
Is that correct?


If the stock moves up, you're likely to get exercised and you loose the underlying stock at the strike price. If the stock price moves down, the call will likely expire worthless, but you're forced to hang onto the stock while its value declines.

<rant>

It's really hard to make money writing covered calls. The best you can hope for is that the stock will trade in a neutral zone and even if the buyer exercises, you might still hold onto some profit from selling the Call.

In my limited experienced, selling covered calls never appears valuable in practice. Of course a broker is more than happy to let a novice cut his teeth on them – he risks nothing and he's likely to make good money from the added trading commissions even as your assets slowly decline in value.

Unfortunately many brokers require experience in covered calls (level 1 option trading) before they will let you buy option (calls or puts) contracts (usually level 2 option trading). This is unfortunate since simply purchasing an ATM (or NTM) Put contract makes for good insurance against a short-term decline in stock price while purchasing an ATM Call is good insurance against a short position.

Also, selling (writing) an uncovered (or cash-secured) Put contract is almost identical to issuing a limit order for a stock – with the major exception that you get paid for the order! – yet brokerages claim this is considered option level 3 or 4 and is only reserved for their best (richest) customers.

</rant>

- Joel
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