Sell Stock or Write Covered Calls?

Seeking Extra Profit.

Stock Certificate
Old stock certificate. Wikipedia Commons

A reader wants some information on writing covered calls.

I am wondering what you think about this:  I want to sell a stock that I don't really like anymore (T). Would it be a good idea to write some Covered Calls or should I just sell the stock outright? I am also reading your book The Option Trader's Mindset.  It is amazing how many things in life can be compared to investing, such as the way we think about business and the things we believe and just take for granted -- that may not be true at all. Thanks, DP.

Yes, I believe that it is an excellent idea to write covered calls on a stock that you no longer want to own. There are two different situations to consider:

  • If you don't like the stock because you are afraid of an imminent, severe price decline, then it is best to just sell the stock. It does not pay to take the risk when the potential profit (the option premium) is small (as it is in a non-volatile, dividend-paying stock such as AT&T).
     
  • If you don't want to own the stock because its future growth prospects are no longer appealing, then there is no urgency to sell the shares and you can try to earn extra money from this position before letting go.

 ​NOTE: The numbers below were taken at a specific period of time, so do not expect that they will be anywhere near the same when you are reading this article. Nevertheless, the discussion is appropriate when different strike prices and expiration dates are chosen.

  • With the stock price equal to $33.48, I'm looking at the 6/19/15 expiration (39 days in the future).
     
  • The Jun 19 '15 32 call is about $1.72, and that represents only twenty-four cents in time premium (The option is in the money by $1.48, and that is the intrinsic value. The remaining $0.24 represents the time value). When , You would sell stock for a net of $33.72 ($32.00 at expiration and $1.72 when the option is sold). When you subtract commissions, that may too small of an extra profit for you -- when it involves holding the stock for another 39 days. On the other hand, although the profit is small, it is better than selling stock at $33.48 (if you are willing to take the risk of holding until expiration).
     
  • The Jun 19 '15 33 call is roughly $1.00, and if you are assigned an exercise notice on that call, your net sale price would be $34 - and that is 52 cents better than selling right now. Again, you must be willing to hold a while longer. This is a good option for covered call writing if you are looking to earn a bit more on the shares before they are sold.

Note: You may get tempted to continue to play this game -- and that is acceptable. But only if you still want to take the risk of owning the shares (and right now, you don't). If the options expire worthless (stock price declines below strike at expiration), then you can continue to write new call options. Even when the option is in the money at expiration, many investors like to cover the call sold earlier and "roll" the option to one with a more distant expiration date. I do not recommend this for someone who is looking to get rid of the stock -- but is is a viable plan for other stocks in your portfolio, ones that you still want to own.

Do not even think about selling out-of-the-money calls. Remember that in this scenario, you prefer to be assigned an exercise notice. The trader who prefers to own shares after the options expire can write any suitable call.

As always, when you write covered calls, there is always a chance that you will not collect the dividend.