In the up scenario, the maximum gain that can be attained
is trade options finishing at $10.00 or higher.
At $10.00, you would profit from the full value of the extrinsic
value of the trade options, which is $.50 and you would also
have $.50 of capital appreciation from the trade options
a total of $1.00. This represents a 10.52% one-month return
or an annualized return of 126.32%.
It is not realistic to expect this type of return from the trade
options every month, but remember, recent studies show that
premium selling works approximately 80% of the time, which is
still very good.
We stated earlier that the maximum return of this buy-write
will be actualized when the trade options reach $10.00 or above
and the maximum return will be $1.00, and no more than $1.00.
As the trade options go higher, the option will earn less in
direct proportion with the increase in capital appreciation.
For example, if the trade options close at $10.30 you would
receive only $.20 from the option. The trade options would now
be worth $.30 because with the stock at $10.30, the 10 strike
call would have $.30 of intrinsic value.
Since you sold the trade options at $.50, you would see a $.20
profit ($.50 - $.30 = $.20). Since you bought the trade options
at $9.50 and it is now $10.30 you have $.80 of capital appreciation.
Combine the two and you have a $1.00 profit.
Lets look at what happens when the stock trades up to $12.00
and see if you again have a $1.00 return on the position. At
$12.00, the trade options will have $2.00 of intrinsic value
(stock price strike price) because it is in the money.
You sold the trade options at $.50 so you have a $1.50 loss.
However, you bought the trade options
for $9.50 therefore you
have a $2.50 capital gain. Combined, you have a $1.00 profit.
In a third example, if the stock trades up as little at $.10
you still have a $.60 gain. You will receive $.50 from the sale
of the call which would expire out of the money thus worthless
plus $.10 of capital appreciation. $.60 represents a 6.3% one
Please refer to the chart below for examples of total dollar
profits per number of contracts, remembering that each contract
controls 100 shares of the trade options.
Observe that if the trade options close over $10.00, then your
stock will be called away because your short calls will be exercised.
In the up scenario, you would profit with the buy-write when
the trade options are up as little as a penny, but you are also
limited on our maximum profit.
You are limited on your maximum profit as defined by the formula
Maximum Profit = Strike Price + Option Price Stock Price.
This method of calculation will work every time. As you see,
the buy-write has a positive but limited upside potential.