Covered Calls

ZYX closes below 45 at expiration - no assignment on short call

In this case, the call option will expire worthless and the investor keeps the premium of $1.25, or $125 total, for the call contract. Since there is no assignment, the 100 ZYX shares will be retained as well. However, the net effective cost of the shares is reduced by the premium taken in. The result is a net share cost of: $41.75 stock purchase price - $1.25 call premium received = $40.50 net. Any dividends paid during the lifetime of the call contract would be kept as well.

If at expiration ZYX closed above the stock purchase price of $41.75 both the covered call writer and the stock investor not writing a call would see a profit on the 100 shares. However, only the call writer�s return would be increased by the $125 option premium received. If at expiration ZYX closed below the stock purchase price both investors would see a loss on the 100 shares, but only the call writer would have the loss at least partially offset by the premium taken in.

After expiration, the covered call writer is now free to write another call covered by the 100 ZYX shares, and can choose a strike price and expiration month that fit his current market opinion and time frame for it. By doing so, taking in additional premium results in an even lower net purchase cost for the 100 shares, generates additional premium income, and provides limited downside stock price protection for the lifetime of the newly written call contract.

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