Selling Calls Against Employee Stock Options

January 11, 2000

Here's another employee stock option question: "What do you think of the idea of selling out of the money long term exchange listed call options in the same stock that I own through my Company employee stock plan? Example: I own the right to buy 2000 shares of xyz at 10, with the stock currently trading at 25. Would it make sense to generate some income for me to sell the Jan 2001 30 call option for $5."

Technically this would be a strike price spread - selling a call option at a higher strike price against a call option one already owns at a lower strike. It's pretty much the same thing as writing covered call options against stock that you own. If the price rises above the strike price, you can supply the stock from your option position, by exercising your pre-existing option. As before, here's a little table of what might happen. We'll leave out the tax situation as it's all going to be ordinary income.

No spread	Value
2000 options @ $10 strike, price now $25	$30,000
If the stock rises to $30	$40,000
If the stock rises to $35	$50,000
If the stock doubles to $50	$80,000
If the stock triples to $75	$130,000
If the stock halves to $12.50	$5,000

--versus--

Sell Call for $5 at $30 strike	Value
If the stock remains at $25	$40,000
If the stock rises to $30	$50,000
If the stock rises to $35	$50,000
If the stock doubles to $50	$50,000
If the stock triples to $75	$50,000
If the stock halves to $12.50	$15,000

So you can see that if the stock declines, or if it rises no farther than $34.99 during the year, you'd be ahead selling the covered call. But if the stock moves up sharply, you'll be leaving a lot of money on the table. Also, if the option you sell is called, you'll be forced to cash in your employee option. Thus you'd owe income tax on it, and whatever you invest the proceeds in will eventually result in another tax bill. Every time money changes hands, it's a taxable event, and you should keep those to a minimum.

How high a premium you'd get is another factor to consider. If you think the company stock is going nowhere and the option premium is a fat one, it's tempting to grab that premium.

Selling the covered call is a conservative move. It reduces your leverage. This may be a good thing or a bad thing, depending on how bullish you are on the company stock, and on your own financial position. If you are young and broke, you want as much leverage as you can get so you have a chance to make some real money. If you are old and have a lot of money, you should be more interested in hanging onto what you have.

© Copyright 2000 by Richard Gillmann. All Rights Reserved.