Options Math for Traders: How To Pick the Best Option Strategies for Your Market Outlook (Wiley Trading) by Scott Nations

Author:Scott Nations [Nations, Scott]
Language: eng
Format: mobi
ISBN: 9781118264164
Publisher: Wiley
Published: 2012-09-30T22:00:00+00:00

Figure 10.4 highlights the covered call breakeven and regret points for LMN Corporation.

FIGURE 10.4 Covered Call Breakeven and Regret Points

The maximum profit from any covered call position occurs when the underlying stock is at the strike price at expiration. In the case of the LMN covered call the maximum profit occurs when LMN is at $80 at option expiration. The maximum profit is also achieved when the underlying stock is above the strike price at expiration. This relationship, maximum profit occurring with the underlying stock at the short strike price at expiration, holds for nearly every option strategy, not just covered calls. We’ll discuss this later in Part Three.

An important element of a covered call is that it limits the profit potential from ownership of the underlying stock. You’re selling much of this profit potential for cash. As we’ve seen when discussing the volatility risk premium, over time, we’re selling this potential for more than it’s worth, but that doesn’t mean it won’t feel like a swift kick to the head when we’ve sold a covered call only to see our stock rally well past the regret point. A central element to successful option trading is to remain disciplined when this happens and make the best possible follow-up trade if there is one. If there isn’t a good follow-up trade then the best tactic is to learn from the situation; again, be disciplined enough to realize that this sort of thing will happen from time to time, but if we have the option math on our side, over time good things are going to happen.

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