# Covered Calls on Cash Settled Accounts



## zac (14 December 2011)

I've a question on writing Covered Calls. Ive recently been getting into this, however as the thread title suggests with my broker Im not getting exercised at all however get Cash Settled. 
So in other words rather than stocks changing hands the cash amount is all thats transferred. So this in effect means I never have my stocks sold when a call is exercised nor do I end up buying stocks if my puts are exercised.

I write monthly calls, so my question is if I use the same stocks month after month to write covered calls; im basically selling my capital gain via the Call, so how do I tell what my break even point is on the stocks say after 6 - 12 months.
Or is it the case that as long as the stocks never go under my share purchase price, I will always atleast break even?

The cash settled component has me confused.
If anyone could shed some light or even direct us to a link that vivdly explains this. That would be greatly appreciated.


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## ROE (14 December 2011)

zac said:


> I've a question on writing Covered Calls. Ive recently been getting into this, however as the thread title suggests with my broker Im not getting exercised at all however get Cash Settled.
> So in other words rather than stocks changing hands the cash amount is all thats transferred. So this in effect means I never have my stocks sold when a call is exercised nor do I end up buying stocks if my puts are exercised.
> 
> I write monthly calls, so my question is if I use the same stocks month after month to write covered calls; im basically selling my capital gain via the Call, so how do I tell what my break even point is on the stocks say after 6 - 12 months.
> ...




As far as I know according to the ASX document only Index options are cash
settle...

Your break even point will be 

strike price + Premium - fees

Say you got QBE now and write QBE Jan Call $14.00 pocket 40c premium

your break even point will be ..I leave the fee out for easy of calculation
$14.00 + 0.40c

stock goes to 14.50 you lose
stock hovering around 14.40 or less you wins.

So if it is cash settle I would assume you be out of pocket 10c if they didnt 
pay you the premium and you be out of pocket 50c if you do collect the premium at the time of the contract .....because everything based around strike price....

If you dont understand options becareful, it's a derivatives which can have significant risk ... writing naked call expose you to unlimited risk...

if you watch some TV show or some seminar telling you ..you can make reliable income from writting options or they called share renting or what ever I execise cautions...

Options do have significant risk attached, people paying you premium for insurance for risk they do not want to take on...so as a writer of options you wear all the risk...also you can face partial early assignment you could be up for multiple transaction fees attached.....you need to understand margin requirement etc...

say you write 100 TLS contracts, the exchange can assigned partial assignment to you at 30, at 20 at 50 and you face with three transaction cost...or if the stock tanks and your margin all used up...you face margin call

Having said that I do use options and all my options scenario I have cash and enough asset to back it even if stock tanks to $0...


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## zac (14 December 2011)

I understand the risks with options and totally understand the risks with them being naked.
Im just trying to get my head around Covered Calls where its being cash settled.
So using your example of QBE;

$14 + 0.40 cents premium.
I assume you meant my break even point would be $13.60.

What I meant was aside from the income generated from calls, when I eventually want to get rid of my shares/stocks, what is my break even point on the shares alone (not including the income generated.

I expect that after enough calls have been written, my break even point on the shares would be close to $0.

Anyway assuming I write ATM calls on QBE every month and then after 12 months QBE rises to $30 and I then sell them.
the gain from $14 to $30 I assume I make no capital gain as I sold that off as part of the option????

Is that the case? 
so example a) QBE rises $14 to $30 & sell- No capital gain 

example b) QBE purchased $14 and sold $14 months later - No loss

example c) QBE purchased $14 and sold $10 months later - $4 loss (however offset by income generated on calls)

So if someone could clarify im on the right track, it would be greatly appreciated.


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## zac (14 December 2011)

ROE said:


> As far as I know according to the ASX document only Index options are cash
> settle...




By the way, the options im referring to arent ASX and are US equities.


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## ROE (14 December 2011)

no that is not how it works
when you write a call you have obligation to meet if the buyer exercise their rights

Buyer= has right no obligation
Seller (you) = has obligation and no right

once you sell an options you are tied to that obligation until the options either expire worthless or the buyer exercise his options early.

You cant chose when to end the options as a seller, your only hope is the options expire worthless.. if the market turn against you, you are out of the money and the buyers at any time can exercise their right and you have to fill the obligation...

say you write an options for $14.00 pocket 40c end Jan
if by the time the options expire in Jan and stocks trades at $14.10 you will get assigned
as it above strike price ....the exchange will assigned anything that has value greater than 1c

so you have to sell the stock at $14.00 u dont have a choice...even stock goes to $100 you have to sell them at $14.00 ..that is the risk...you forgo all the upside for the premium when writing covered call...
and if you dont have the stock and writes naked call you are F**Ked 

you have to buy stock at $100 and sell back at $14


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## ROE (14 December 2011)

zac said:


> By the way, the options im referring to arent ASX and are US equities.




Cash settle or not ..the options contract are the same in Australia as in US

Buyer=has right no obligation
Seller=has obligation and no right

Equity Options American style both in Australia and US
Index Options is Euro  style


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## zac (14 December 2011)

I dont think im making my point clear as I understand all that bit.
The underlying stocks I own will never be sold from under me due to being 'Cash Settled'
I DONT intend on buying back any of my options and will let them go till expiry or exercise (cash settlement)

The question im asking isnt so much about the options but more so about the shares I own.

To make it simpler (I hope)
if I buy $14 shares (in lots of 100) and write calls against them.
No matter what I sell them for at a future date, they'll only be worth $14 to me?
due to selling off the upside potential/capital?

However if the shares fall under $14 I make a loss if I sell them at a future date? (although losses will be offset by all the premiums ive received from them)

I hope that makes it simpler to answer.

I understand the issues with options and the question is focused on the stock/shares.

I think the issue of 'Cash Settlement' is what is confusing here as perhaps its something a lot of people are unfamiliar with, but the way it works (with this broker atleast) Exercise of options NEVER EVER results in the trading of stock, ie Buy/Sell but only cash settling the difference whether profit or loss.


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## wayneL (14 December 2011)

Cash settled? On stock options?

Who is the broker?

This isn't some MM model is it? eg IGMarkets or one of the CFD shonks?


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## zac (14 December 2011)

I dont want this to get into an argument or a slanging match about brokers.
Im quite comfortable with my strategy and the broker but wanted to confirm how the Cash Settlement worked.

I take it from the last response Cash Settlement isnt common practice so therefore no one has any knowledge to call on to answer the question in the OP??


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## suhm (14 December 2011)

So are you already doing this? It is a bit odd to be doing something if you don't know what the consequences are.


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## peter2 (14 December 2011)

Assuming you sell a $14.00 call and receive 0.40 premium credit. 
At expiry the underlying share price is 15.00 which would normally be exercised. Does the cash settlement process (which is very different to the exchange traded options process) debit you 15.00 or 1.00 (+fees). 

If the options are disconnected from the shares then selling the shares will result in a capital gain or loss as will the net result of the option debits and credits.

The BE for the shares is the price paid (including comm).


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## wayneL (14 December 2011)

zac said:


> I dont want this to get into an argument or a slanging match about brokers.
> Im quite comfortable with my strategy and the broker but wanted to confirm how the Cash Settlement worked.
> 
> I take it from the last response Cash Settlement isnt common practice so therefore no one has any knowledge to call on to answer the question in the OP??




Who's arguing?

You said you were confused about cash settlement.

I am confused about cash settlement.

There must be a non transparent reason for it, if you want answers, we need full disclosure so we can give you correct information.

As far as I am concerned, these must be OTC options to be cash settled, unless there is something else you ain't saying.


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## ROE (14 December 2011)

best if you post a link to this broker so everyone on this forum can read
and I can have a poke around and see how they settle cash options...

I'm usually pretty good at picking out stuff when I smell scam or bull**** 

I'm not aware of many places that do cash settle on equities stock, must be another financial engineering tools ready to be sold to the mass.

Options usually goes via an exchange in Australia it's the ASX, In the US there are a few but the biggest one probably be Chicago Board Options Exchange.

Have a look through there to see if they do any cash settle with equity, most only do index.

If not then you are probably deal with Over the Counter and I usually don't go near there.

Give people some information so they can help you...


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## cutz (14 December 2011)

zac said:


> II take it from the last response Cash Settlement isnt common practice so therefore no one has any knowledge to call on to answer the question in the OP??




Cash settlement is common practice on index options on expiry day on the *in the moneys*. If the stock options you are dealing with are euro expiries, cash settle should work the same way as on the index options, ie, difference between strike and settlement price times the multiplier, you pay up if you are short, you get paid if you are long.

BTW, i've never heard of cash settled stock options.


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## peter2 (14 December 2011)

zac: You are probably using one of the two main cfd companies in Aus. and everything you trade with them is a cfd. The options are even cfds (but you know this). I assume you are monitoring your trade results and P+L carefully. You can calculate your BE prices using any method you choose. You can group all the share-cfds trades together or all the option-cfds together. It's the P+L at the end of the year that matters. If you are making regular profits and happy with the ROI, keep going, until you save enough to use the proper exchange traded products. They're safer and much cheaper. 

It's your combined P+L at the end of each FY that might be a capital gain /loss. This depends how you are operating and you will need to see a tax accountant to get it right each time you do your tax return.


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## zac (15 December 2011)

Thanks for all the replies so far.
I am currently doing these trades, but I sell the Shares/CFDs at the end of each month.
Also my options have always gone through to expiry so ive never had to be concerned thus far with being exercised (cash settled)

The reason im asking is im being analytical and wanting to sort out the most profitable way to trade options.
Im thinking if I write ATM or OTM calls that im selling off any capital gain so therefore my $14 stock ( as an example) will always only be worth $14 to me as long as I only ever sell it at $14 or above.

I might direct this one to the broker but when I queried them last time they werent too helpful with an answer.


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## wayneL (15 December 2011)

zac

I'm afraid if you're trading OTC products (CFDs and CFD options) your going to have to throw out the rule book and refer to your broker/smarket makers(MM) terms and conditions. 

I also strongly suspect your only possible counterparty is the MM itself, so I'd be interested how these are priced relative to the "real" options market.


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## wayneL (15 December 2011)

OK I just read IGMarket's blurb on their CFD options:



> > *It is important to note that when you trade an option with IG Markets the option will not be exercised on expiry.* Instead the trade will settle at its expiry value, as follows:
> >
> > For a call option the expiry value is the level of the underlying minus the strike price
> > For a put option the expiry value is the strike price minus the level of the underlying




Like I said, read your brokers T's & C's and throw out the rule book.


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