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This is the return the trader will realize if the short calls are exercised and the underlying shares are called out. After computing the call’s time value ($1.00, since the call is $1.50 ITM), simply divide the time value by the net trade debit. If the calls are ATM or OTM, it assumes they are not exercised but if the calls are ITM, their exercise is assumed.ġ) Determine call’s time value ( premium – intrinsic value)Ģ) Determine net trade debit ( stock price – total call premium)ģ) Divide time value by the net trade debit ( time value ÷ NTD)Įxample: The stock costs $19 and the 17.5 Call is sold for $2.50. The flat (static) return is the potential return on the covered call write assuming that the price of the underlying stock has not changed by option expiration. The following two tables demonstrate the calculation of flat and if-called returns. While the $3.25 of total premium provides nice downside protection to $16.92, the return will be calculated on the 0.58 of time value.įurther, the covered call return is computed upon the net trade debit (S-C), the cost basis after buying the stock and writing the call, because that is the amount at risk. But if $2.67 of it is intrinsic value and only $0.58 of it is time value, the return is not as good.
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In a Call Strike Analysis example where the ITM premium is $3.25, it may seem large. There probably is no more common mistake in assessing returns than to look at a fat ITM premium and forget that part of it is intrinsic value. The if-called return also includes the extra profit realized from being assigned on an OTM call strike. Thus you must know the time value in order to calculate the return.
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If a premium is all time value, then it is all return. The calculation of return in a covered call trade is based solely upon the time value portion of the premium.