The “Up” Scenario In Trade Options

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 for 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.

Let’s 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 month return.

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 below:

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.