When you’re the proud owner of an in-the-money call option, there are three ways you can choose to take your profits.
The most obvious and popular way is to close the position outright by telling your broker that you want to “sell to close” the position. So, if you purchased an option for $1 and closed it for $4, you’ve just made a nice, straightforward $3 profit.
Another way to cash out your position is to use the call to purchase stock at the option’s strike price. Many investors like trade call options because it gives them the opportunity — but not the obligation — to shares at an attractive price, especially if a recent run-up made the calls escalate in value.
If you bought the XYZ Oct 30 Calls for $1, it gives you the right to buy shares of XYZ at $30. And if your call is in-the-money, this means the market value of the shares is above $30, in this scenario.
Let’s suppose shares are trading at $35 — this means you’ve actually profited $4 so far. How? Because you’ve spent $31 per share, which is the strike price at which you bought the stock, plus the buck you paid for the call options).
So, if you wanted to sell the stock on the open market at $35 and you’ve only paid $31 a share, you’ve made a dollar more than the investor who bought the call at $1 and sold it at $4. As a bonus, you’ve managed to initiate a long position in a stock you wanted to own.
There’s a third option for taking profits on your in-the-money call. You can lock in your gains without going to the options markets by selling stock against your calls.
With both stocks and options, there’s a spread between the bid price and the ask (or offer) price.
(The bid is where buyers are willing to purchase an option, and the ask is where a seller is willing to part with the option.)
In most cases, a nickel or dime’s difference mig! ht not m ake much of a difference to you when you’re closing or even opening a trade. But what if that spread were 50 cents? (Example: if the bid is at $4 and the ask is at $4.50.)
Your XYZ Oct 30 Call means you own the right to buy stock for $30. But rather than “selling to close” those calls, you could instead sell a commensurate amount of shares against your options to lock in a slightly higher return than by selling the calls. Since the spread is 50 cents wide for the options, it seems foolish to give up that much by hitting the bid.
Suppose the stock’s trading at $35. You can sell shares at $35 against your calls at the $30 strike, which means that with the calls you hold, you can buy shares at $30 — a $5 profit already — to cancel out the position. Subtract the cost of the options ($1) and you’ve closed your trade at a $4 profit.
Selling stock against your calls might take a little more work to eke out more profits, but it’s worth considering, depending on the individual trade. In this scenario, it earned you an extra dollar (or $100 per contract) compared to closing the trade outright.
It might not be the right solution to all your future trades, but if you do the math and the “extra” profits are worth the extra effort, it’s a great strategy to help you to not only trade like pro, but also to close the deal like one, too!
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