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I’ve not found anyone who can give me a decent answer about DITM covered call writing.
Let’s say investor X has a long-term stock position and has made some nice profits over the years by writing covered calls on it, and collecting its quarterly dividend.However, his investment thesis has changed, and the stock is trading at $6.50, down from his initial cost basis of $9.Looking at the call chains, the investor looks for a covered call to sell, perhaps allowing him to recover his unrealized capital loss on the position.
My belief is that history is irrelevant.Whether the position has been a winner or a loser should have no bearing on your decision concerning what to do now.
According to his broker, a front-month very DITM call (all intrinsic value, delta = 100) would give a $4 credit and the b/e on the position of ~ $6.50. As investor X sees it, the premium received would more than offset the unrealized capital loss on the position, and come expiration, the underlying would be called away at $6.50. Thus, the investor has used options to “dump” his shares and recoup his paper loss. Sure, the option sold is already in the money, but the plan would be to allow the stock to be called away anyway.
Is there something I am missing from this hypothetical strategy I describe?
When you sell a covered call (CC) the profit potential in the trade is represented by the time premium in the option.Writing options with zero time premium is a very bad idea.You have nothing to gain, pay commissions to the broker, and incur risk.If your plan is to accept $6.50 for the shares, better to just sell them now, rather than wait for expiration to arrive.
That time premium is your reward for taking the risk of holding the position through expiration.If the stock drops below $5 per share by then, you will lose more money.Thus, this is not a free play.There is some risk.That’s why you must have an acceptable (to you) reward for taking that risk.
When you sell the DITM at parity (zero time premium), you gain nothing for the risk you take.