Closing on the Delta

Let's take a look at what happens if there is increase in the price of the stock we have written a covered call against. This is represented in the CSE flowchart (Hooper and Zalewski) in the second box underneath and to the right of "Enter New Position." It is labeled "Stock Increases" and contains two possibilities; 1.) Close on the Delta Effect or 2.) Get Called Out

Let's look at number two first, get called out. According to Hooper and Zalewski, getting called out is one of the primary aims of covered call writing. Getting called out means your stock appreciated in value to the stock price, you keep the premium received when you wrote the option and you profited by the gain in the position which will be the difference in the strike price and your purchase price. If you are following the rules as previously noted, you will at a minimum receive a 4% called return.

Closing on the Delta Effect

The Delta of an option is simply the percentage increase in the option relative to the stock price. For instance, if an option has a .60 delta, for every dollar the stock increases in value the option will go up by 60 cents. What this means for you, the covered call option writer, is that there may be an opportunity to close out the position early by buying the call back early and selling the stock for a profit. If you can get a minimum of 4%, then do it. You can determine your profit by calculating the following formula.

Sell Price of the Stock - The Original Buy Price of the Stock + The Premium Received From the Call Write - The Buy Back Price of the Option (the Ask Price)

The calculation of this formula results in the net profit on the transaction close.

For example, let's say Bill buys APOL at $30 and sells a June $30 call for $1.00. The delta of the call for this example is .50. If the stock price jumps $3.00 after entering the position, the option price will only jump by $1.50. The sell of the position will look like this.

Sell Price of the Stock $33

- Original Buy Price $30

+ Premium Received $1.00

- Buyback of Option $2.00

Net Profit $2.00 or 6.7%.

As you can see in the flow chart, if Bill closes the position on the Delta effect (the stock price has increased significantly in relation to the option price), he has closed out his position by buying back the call and selling the stock and now moves to "Entering a New Position" and the accompanying rules.