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"What Happens To My Covered Call On Citigroup?"
Question By Farzin

"What Happens To My Covered Call On Citigroup?"

Hello: I own 500 shares of citi C for $4.00 each. On Feb 6 I wrote a sell to cover call option @42.00 for march 21th $5.00 per contract for 5 contracts. this is what my transation says. call-100 C MAR @ 5 Opening Trans- Covered Mar 21 2009. what I should be doing before March 21TH if the strike price is below $5.00 and if it is above $5.00. I thought I knew what I was doing to protect my investment, But I am now confused? Please reply. Thank you so much.

Asked on 23 February 2009

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Answered by Mr. OppiE

Hi Farzin,

To reiterate your question, you bought 500 Citigroup (C) shares when it was trading at $4 and then you wrote a covered call against it by selling the March $5 Call Options at $0.42 for a total of $210. You are wondering what is going to happen if C closes above $5 and below $5 upon expiration of the March options, right?

Ok, here's what will happen...

If Citigroup shares close above $5 upon expiration of the March call options, your Citigroup shares will be called away due to the call options being in the money and you would make in profit the rise of the stock up to the strike price of the call options sold + whatever amount you sold the call options for. Which means that you would make a total profit of $500 + $210 = $710. If you do not want your Citigroup shares to be called away, you could Buy To Close those call options on expiration day itself. In fact, if Citigroup shares rises significantly above $5 before expiration, you could also Buy To Close those call options before expiration in order to benefit from further rise in the price of the shares.

If Citigroup shares fail to exceed $5 by expiration of the March call options, those call options would expire worthless and you would pocket the full amount of its premium. In this case, if Citigroup shares closed at $4.50 upon expiration of the March call options, you would pocket the whole $210 premium + the $0.50 profit per share on your Citigroup shares for a total profit of $460.

What this covered call does not do is protect your position should Citigroup shares drop more than the price of the call options that you sold, which in this case is $0.42. In fact, Citigroup shares has dropped $1.77 since 6 February, which means that after offsetting the value of the call options you have sold, you would still be in a loss of about $1.35, which is still better than not having the calls sold in the first place.


In conclusion, Covered Call is a nice way to protect stocks that are may run into slight retreats but is generally expected to go up. If a stock is expected to go up but may also take a plunge, a Married Put should be used instead. Also, never try any options strategies before you have practised them on paper or in a virtual trading account.

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Response by Farzin...

Mr. OppiE

Thank you for your prompt response. I did the above transactions after I read about options in your site. I will be using this site to learn more and really appreciate that you took your time to answer my question and clear my mind of the doubts I had.

Sincerely
Farzin


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