Advanced Micro Devices Inc (AMD)

[Elmer Phud]

Keith - can you give a short explanation in simple terms of how this works?

Sure. It's quite simple. I assume you know what an option is but just to review, a Call option is a contract between the buyer and the seller whereby the buyer has the right (but not the obligation) to purchase 100 shares of a given stock at the agreed upon price (called the "strike price") up to the time of expiration, which is the 3rd Saturday after the 3rd Friday of the month the option is written for. The reason for the strange wording there is because if the month starts on a Saturday then options for that month expire on the 4th Saturday. The last opportunity to trade an option is the 3rd Friday.

The seller has the obligation to deliver those shares at the agreed upon price should the buyer decide to exercise his option. The term "Covered Calls" means the seller has the shares already in his possession and can deliver them to the buyer out of his own account or inventory. If someone choses to write Calls for shares he does not currently own, that is called a "naked" position. Should the buyer chose to exercise a Call for which the seller is "naked" the seller must purchase those shares on the open market at whatever the current market price is. A a general rule, I do not write naked calls because of the risk involved.

For assuming this obligation the seller is compensated by what is called the "premium" which is the cost of the option to the buyer. Upon expiration the contract ceases to exist and the seller has no further obligation. The seller always keeps the premium regardless of further activity.

The strategy often used is for the seller to write a CC with the hope and expectation that it will expire without being exercised. The seller hopes to gain a premium as a source of income or to further add to the gain of a stagnant stock.

Using AMD as an example we find that at this moment an August $7.50 call commands a premium of about $0.25. Not a whole lot of money but it does represent over 3% for a month. The seller must realize that should the price rise above $7.50 he will not enjoy any further gain. The buyer is hoping AMD will go well above $7.50 and his money at risk will return all the price difference above $7.50.

Commissions do apply and affect the profit/loss calculations.

The opposite of a "Call" is a "Put" and we can discuss that too if you like.