stock has risen to $52, those FAJ contracts may now be worth
$3, in which case buying two contracts would cost you $600.
This translates to a $200 loss. On the other hand those options
may have gone down in price to $1. Maybe because Ford's stock
has declined in price or you are closer to the expiration date, or
a combination of both factors. In that case offsetting the 2 FAJ
contracts would cost you $200 (two contracts at $1 premium)
and you keep the $200 difference.
- The options expire worthless. If you hold onto your position
until the expiration date and Ford's stock price on the
expiration date is $50 or less, those options would expire
worthless. The holders will not exercise them at that point since
they could buy Ford shares at $50 or less from the stock market.
With the options expired, your obligation to the holder is
terminated and you keep the $400 proceeds that you collected
when you wrote the contracts.
- The holder exercises the options. This means that you are now
obligated to sell 200 shares of Ford to the holder at $50 per
share. Normally this would only happen at expiration. No one
would exercise an option with time left as they would forfeit the
time value by exercising, but theoretically they can as they have
the right to do so. Now if at expiration Ford happens to be
trading above $50, you can rest assured that those contracts will
be exercised. This is known as assignment, where the shares
represented by the call options are taken away from the option
sellers and assigned to the option holders. Unlike futures,
options are not cash-settled at expiration. You actually would
need to come up with the 200 Ford shares and sell them to the
holders (through OCC of course) for $50 per share. How are
you going to do this? This is a good segue into the next section.
After that we will return to and conclude our discussion of
writing call options. …