Selling call options against shares of stock you hold is called covered call writing. You receive income from selling the call options, but are obligated to deliver the shares if the buyer decides to exercise the calls. The call-option details include the stock price at which the buyer will pay if she exercises the option. A stock price above the exercise price means you need to make some decisions about your stock holding.
Call Option Function
A call option gives the right to buy a stock at a preset price -- called the strike price -- for a specific period of time. In exchange for this right, the buyer pays a premium to the seller of the call -- who is another option trader. Option sellers earn the income from the premiums and are obligated to fulfill the sold contracts. Because all options expire, the call option buyer hopes the stock will move above the strike price before the expiration date, and the seller would like the share price to stay below the strike price.
An investor can earn extra portfolio income by selling calls against stocks held in his portfolio. For example, the investor owns 100 shares of a stock priced at $24 per share. He sells a call option with a strike price of $25 and receives a premium of $200. A single option contract covers 100 shares of stock. The investor earned and extra $200, or 8 percent, on his stock investment. The option will expire in two to six months, depending on the selected expiration date.
Call Option Exercise
When the stock price moves above the call-option price, there is potential for the call to be exercised at any time. Exercise notices are assigned randomly by the Options Clearing Corp. (OCC) to option sellers. If you receive an exercise notice, the stock shares will be called out of your account, and you will receive the option strike price for the shares. If the sold option is not exercised, and the stock price is above the strike price on the expiration date, the options will be automatically exercised, and your shares will go away and be replaced with cash.
Option Seller Options
When the stock price moves above the sold call option strike price, you must make a decision whether or not you want to keep the shares. If you decide you want to hang onto the shares, you can enter a buy order for the options you sold, cancelling out the outstanding option position in your account. You might have to pay a higher price for the options than you received when the contracts were sold. If you are OK with receiving the option strike price for your shares, you can let the contract be exercised and receive cash for your shares to invest in another stock.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.