What Is The Effect Of Covered Call Writing In Your Account?

When you write or close a covered call, what happens in your trading account? This is not complicated but you need to know what the effects will be and how to read your account statement. While every broker presents the information somewhat differently, they all reflect the same basic information.

The Account Balance

The following illustration shows the account balance of a hypothetical trading account in the form presented by discount broker optionsXpress assuming we had just opened an account with $50,000 in cash and had executed no transactions yet:

The statement of total account value above reflects no securities positions. It does show that the broker is allowing full (100%) margin as the initial margin requirement on stock positions, which effectively doubles our buying power to $100,000. Actually, 100% margin means that the broker really is allowing 50% – meaning that we must put up 50% of the trade cost. But no margin is offered on options or futures, meaning that all long options and futures positions must be fully paid for. Margin can be offered on short options and futures positions (e.g., naked puts), but it is discretionary. If no margin is offered, short positions must be fully cash-secured.

Account Position Statement

Similarly, our account position statement will not yet show any securities positions, since there is only cash in the account. Our initial account position statement would look like this:

Effect of a Covered Call Write

Now let’s go back to the CSCO trade in a previous article. Let’s assume we have opened the CSCO trade by purchasing 500 shares of CSCO and writing 5 of the May 20 Call contracts at a net price of $18.45 per share and look at the effect on the account, which will take trade commissions into account.

TRADING ACCOUNT NOTE: When entering a net debit limit order, we don’t focus on the respective stock and call prices, since we are entering a combination order; we care what the net debit is – how much we pay to get into the trade. However, our account will show the actual fills we got on the stock buy and the call write.

We will also assume we paid a commission of $14.95 for the stock leg of the trade and $14.95 for the option leg, for a total commission load of $29.90 for the entire order.

Symbol Descr. Stock Qty Cost Basis Total

Cost Basis

Current Price Market Value Gain/ Loss
CSCO Cisco Sys 500 19.75 9,875.00 19.77 9,885.00 10.00
CYQED CSCO MAY 20 Call -5 1.30 – 650.00 – 1.25 – 625.00 – 25.00
Total cash     40,745.10
Account Value     50,005.10

Effect of Trade Open. Our cash balance was reduced by the $9,875.00 stock buy, reduced by the $29.90 in commissions and increased by the $650.00 in call premium received; together reducing the cash balance to $40,745.10. In calculating the account value, however, notice that the market value of the May 20 Calls is treated as a debit, not part of the account value. Here is how account value is computed:

Cash                                                              $40,745.10

Total securities value                      $ 9,260.00         ($9,885 stock value – $625 value of calls)

Account Value                                      $50,005.10

Premium from the calls written thus was not literally cash in your pocket – it simply acted as an offset against the price of the CSCO shares. When the stock is later sold, or the calls expire worthless, the return from writing the calls will be realized. Now our account balance statement automatically updates to reflect the CSCO call write:

Note that the total account value is $50,005.10, which is the total cash added to the total securities value. The account value changes by the minute, because the broker always values securities at their current market prices. (Of course, the historical buy and sell prices in the account history do not change.) After the market close, the securities value will be based upon the last market prices. The stock value is shown at current market value ($9,885.00) and the current price of the calls ($625.00) is shown as an offset against the stock value – because the calls may have to be bought back and thus are treated as a liability – resulting in a total securities value of $9,260 (9,885.00 – 625.00. If the calls expire worthless while the stock still is in the account, the negative market value attributed to the calls will disappear from the securities balances, which increases the “total securities” value. Had we bought calls instead, the long calls would have been a positive (not negative) item in the account statement.

Effect on Available Margin

Now take a look at how margin has been affected. The margin amount has changed due to the transaction just effected. Margin is calculated as cash in the account plus the total (net) securities value of all marginable securities in the account multiplied by the margin percentage, which in this case is 50%. The new margin amount available (the margin release) is $45,375.10, which is calculated in this manner:

Cash                                                             $40,745.10

50% of securities value                                    $ 4,630.00         ($9,260 x 50% = $4,630)

Margin Available                                 $45,375.10

The stock buying power amount of $90,750.20 is obtained by doubling the $45,375.10 margin amount available. Option and futures buying power remain unchanged, since no margin is offered on them in this account. Reg-T margin is assumed here, not portfolio margin (discussed later).

Effect of Closing the Covered Call Position

Trade Close. Now let’s review the effect of closing the CSCO trade on the terms discussed in the previous section. Assume we sell the 500 shares of CSCO and buy to close the 5 May 20 Call contracts at a net price of $19.25 per share (+19.85 for the stock and – 0.60 to close the calls) – a gross profit of $0.80 per share or $400 – and look at the effect on the account, which will take the two trade commissions – one for the stock sale, one for the call repurchase – into account.

Symbol Descr. Stock Qty Cost Basis Total

Cost Basis

Current Price Market Value Gain/ Loss
Total cash     50,340.20
Account Value     50,340.20

After closing the trade, which required buying back the calls, our securities value naturally shrank but we are now up a net of $340.20 after total trade costs of $59.80, a final return on the trade of 3.7% for a one-week trade ($340.20 ÷ $9,225 orig. net trade debit). Our nominal 4.3% return was reduced by trade commissions, though the extra $0.05 we picked up on the close more than offset the commission.

Instead Going to Expiration (no close). Finally, let’s assume that we did not close the trade early but let it go to expiration. We’ll further assume that the stock price settled back at $19.75 by expiration (price was flat: the same as our entry), that we were not called out, thus the calls expired worthless and that we sold the stock the Monday after expiration for $19.75 per share:

Symbol Descr. Stock Qty Cost Basis Total

Cost Basis

Current Price Market Value Gain/ Loss
Total cash     50,605.15
Account Value     50,605.15

Since in this example we didn’t buy back the calls, we received $19.75 per share ($9,875.00) and only paid the single commission of $14.95. Adding the $9,875 back to our cash balance and deducting the $14.95 commission to sell the stock, our cash balance is up to $50,615.15. Our final return is thus $605.15, or 6.6%, for a four-week trade duration, nearly double the return for closing early. Though double the rate of return, the trade duration was four times longer, thus the rate of return for the trade’s length was lower than if we’d closed the trade after a week. Here is a comparison of the rates of return from closing early vs. going to expiration, normed to a 30-day month:

Early Close:                                     15.6% (3.7% ÷ 7 days = 0.52) x (30 days)

Going to Expiration:                  6.6% (6.6% for 30 days)

Next time, we’ll take a brief look at margin. Even if you don’t use it, you should know how it works.

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