FAQs about Covered-Calls
One of the principal concerns for an investor who sells covered-calls against long-term portfolio issues is the possibility of early exercise of the short options. In those instances where the value of the shares rises substantially after the calls are written, the easiest way to avoid assignment is to adjust the position by "rolling" the calls up to a higher strike price. When a position is rolled up - by repurchasing the current (sold) calls and selling higher strike calls - the profit potential is generally increased. The "catch" is that downside protection is surrendered. The new (downside) break-even point will be increased by the amount of money required to complete the roll-out transaction; the cost of closing the sold calls minus the credit received for selling the new calls. When using this technique, it is important to be sure that any debit incurred is worth the additional risk. One way to offset the cost of the position adjustment is to roll to a future expiration date in the sold option. Selling a longer-term call will increase the amount of money received, possibly even yielding a credit in the transaction.
As far as in-the-money options and the possibility of early assignment; there is little risk of this outcome as long as some amount of extrinsic value exists in the call option. Even if there is no demand for the option, a certain amount of time value will exist prior to expiration thus there is usually financial incentive for the owner of a call option to sell it for a premium (as compared to intrinsic value) rather than exercise it. Of course, there are situations where a dividend "capturing" opportunity may make the option a candidate for early exercise. This typically occurs when the dividend the buyer will receive (if the call is exercised) is greater than the interest expense incurred for carrying the underlying shares through the ex-dividend date. At the same time, if the option is in-the-money and the expiration date is near, it may be best to roll forward in order to reduce the likelihood of the options being exercised. An investor can simply repurchase the sold options and sell new, longer-term calls, either at the same strike price or in a different series; whatever is consistent with his or her outlook for the underlying issue. While statistics suggest the percentage of options exercised prior to expiration is very low, there is a much higher probability of arbitrage by institutional traders, floor brokers, etc., when the extrinsic value falls to zero; the option is bid at parity or less. The best way to prevent an unexpected assignment is to monitor the option's price whenever it moves in-the-money and if there is little or no extrinsic value, initiate the process of rolling the sold calls up, or up and forward, to prevent losing the stock and possibly, a future capital gain.