Hello, everyone, and welcome to Schwab Coaching. My name is Cameron May. I'm a senior manager here at Schwab, and this is Getting Started with Options. And you know, that process of learning about the world of trading options can feel pretty intimidating at times. I think that anybody watching here who has some experience with options would agree. Lots of different strategies out there, actually dozens. You know, there are things called iron condors and straddles and butterflies, and it can all sound like so much to really take in, but really, all of those strategies are built on four basic building blocks. The good news that I have for you today is that there's only two types of options out there. There are calls and there are puts.
And there are only two things you can do with calls and puts. You can buy them or you can sell them. Those four things, buying and selling calls and buying and selling puts, make up the building blocks of all strategies out there so if a trader can really understand each of those four things, those four, they've taken a big step forward to understanding everything that's on offer in the world of options trading. So in lesson one, we introduced ourselves to buying calls and in lesson two, buying puts. This is lesson three in our series of getting started with options. In this case, we're talking about selling calls, or in other words, short calls. So looking forward to a good discussion. We're gonna be rounding out our fourth building block next week.
But before we can get into today's discussion, let me first of all say hello to everybody who's chatting in already out there on YouTube. Great to see Will and Go Girl, Robert, Selva, Mighty Mouse, David, Kevin, Sharon, Eva, Tony, Paul, everybody else. Thanks for joining us week after week. We really do appreciate your attendance and your contributions to these discussions. If you're here for the very first time, wanna welcome you as well. And if you're watching on the YouTube archive, after the fact, enjoy the presentation, but be aware that you're invited to join us in a live discussion. If you'd like to be here, this is a Tuesday webcast series. It kicks off promptly at noon Eastern. We'd love to have you in the live stream audience.
And I also wanna let you know that our very good friend, Connie Hill, is gonna be joining us in the chats today. Connie's gonna be addressing any questions as long as they're on topic. If I can't get to those questions, Connie's there to pick up the slack for me. Thanks for having my back there, Connie. And you can also follow Connie and me on X. That's another fabulous educational resource is available to you for no cost. You can follow Connie on X at ConnieHill, and you can follow me there at CameronMayCS. But let's get right into this. And of course, as we do, the first thing that we need to do is pause to consider the risks associated with trading and investing. Risks are real, so bear these important disclosures in mind.
Options carry a high level of risk and are not suitable for all investors. The covered call strategy can limit the upside potential of the underlying stock position as the stock would likely be called away in the event of a substantial stock price increase. Schwab does not recommend the use of technical analysis as a sole means of investment research. And investing involves risks, including the loss of principle. Okay, so here's where we stand in our series. We have a series of 10 lessons planned. You can go check out lessons one and two already on our Trader Talks archives. But in lesson one, we talked about building block number one, long calls. Lesson two was building block number two, long puts. Today is lesson three, building block number three, short calls.
And then next week we'll proceed onto that fourth vital building block of all options strategies, which is short puts. All right, so here's what we are going to accomplish today with our discussion of short calls. First thing that we're gonna do is address a strategy that involves a short call. It's known as a covered call. I think that, you know, I can't ever state things as an absolute, but I think that many traders would consider this strategy that we're gonna be discussing today as possibly the most conservative of the option strategies out there. We wanna talk about, just because it's conservative, it certainly does carry risks. We're also gonna talk about the reward potentials, but we're gonna talk about what covered calls are, involving a short call, what they are and why they might be done, the basics of doing a covered call or a short call and its implications.
We're gonna place an example trade, and of course, then we're gonna move on to step number four, which is just gonna be a discussion of short puts next week. Okay, so let's get right to it. Let's talk about short calls and I wanna set the, I wanna set the stage here just using an example stock on the thinkorswim desktop trading software platform. Now, I'm gonna be using this platform all the way through this series, so if you haven't downloaded this, you can download it from your Schwab online account for free. Just go to the trade tab and look for where it says 'Thinkorswim' in the drop-down menu, and then just log in using your Schwab username and password into that software. And that'll give you access to this charting tool along with lots of other tools on the platform.
But I wanted to have a look at what's going on with Google or Alphabet recently. Let's put ourselves in the shoes of a stock owner for just a moment. Let's say that, I don't know, back sometime earlier in the year, we bought Alphabet. So we thought it might go up in price and that it's actually accomplished fairly handsomely through the course of the last 12 months. So as a shareholder, of course, what we'd like to see is for price to just keep going up and up and up, white candle after white candle after white candle, just keep going higher. But we also know that's not the way stocks actually move. More commonly, yes, a stock that's moving higher might race up, but then it might also have a period where it pulls back for some extent, or maybe just goes sideways.
It might race up again and then pull sideways. So even in an uptrending stocks, there tends to be kind of a stair-stepping process. It's like two steps up, one step back, two steps up, one step back. And as a stock trader or a stock investor, maybe we're just okay with that. And we just wait as it's stepping back, just wait if the stock persists higher, ultimately. We still have that potential for upward movement for capital appreciation in our price. But is there maybe something else the trader might do during that time when they think a stock is about to kind of go sideways or even down for awhile, so like in this timeframe, or maybe during this timeframe where the stock isn't going up? Well, let's look at what's going on with Google at the moment.
So over the course of the last six weeks or so, Alphabet has net pressed higher, but it's also been bumping its head against a price ceiling. And for our check. trader who maybe owns the shares of stock and they're okay with just holding on, maybe can just keep going higher, and maybe price appreciation continues after some time. But let's just suppose that our owner, again, what I've done here actually before the webcast started, I went and bought 100 shares of Alphabet, just to make this a little bit more real of a discussion. So now, let's put ourselves again in the shoes of the owner of those shares and let's say they think price is going to go down for a while, maybe it's going to repeat one of these last few retracements that it's had over the last six weeks.
Could just choose to sit that out or while they're waiting to go through this sort of unproductive phase of not really any capital appreciation, maybe there's something that might be done with options to bring in some growth potential. Maybe some people describe this as an income strategy, but yeah, what we're going to do during this phase is is sell a call option, in other words, we're going to short some uh short a contract for a call, okay. So I'm going to do that and now as we do it I want to talk about what it is we're getting ourselves into so I'm going to go to the trade tab and I'm going to structure for us this thing known as we're going to call this today's example trade which is a short also commonly known as a covered call and it begins with stock ownership, so let me go see how much I paid for these shares-199 and 12 cents.
So it does begin with stock ownership; we buy 100 shares of stock, yes, this is Alphabet in this example, and in this case, I'll just make note that we paid $199. 12 cents before the webcast started for those shares. It'd be nice if those shares went Up to 200 and then we'd be able to buy 100 shares, 210, 220, 230. But it looks like we're just sort of hitting a pause point potentially. So at this point, maybe the trader adds to this stock position and they go enter into a contract, and here's what we're going to do with this contract: what we're going to do for in our example trade for the next 31 days, or in other words, through the 21st of February.
We're going to enter into a contract where someone is going to pay us for the exclusive right to buy our shares for a certain amount. For the first two discussions, we talked about taking the role of the buyer of the options; in this case, we're Taking the role of the seller of the options, we're going to be selling a call option to someone else and in exchange taking upon ourselves an obligation. So let me just outline this numerically here: how about for today's example with the stock trading you know it looks like our price ceiling appears to be around that 200 level I'm going to do this let's go up to to 205. I'm going to sell for the next, how many days did we decide? 31 days.
Let's go right up above today's candle. I'm just going to draw in a line at about $205. Okay. That's just to give you a visual reference point. And let me clean off the rest, some of these other drawings because they're not going to be needed for the rest of this discussion. There we go. Nice clean chart is always nice for the learning experience. But let's go to our options chain for Alphabet. Look down here at the 21st of February. I'm going to look down to 205 as our strike price. And what I'm going to do here is strike a deal where I'm agreeing to sell potentially my shares of stock to someone else for $205. And in exchange, they're paying a premium to me.
Now, the first two weeks, we talked about paying premiums to someone else. In this case, taking the role of the seller, we're accepting a payment from another trader out there. So let's say that we're able to sell that for $5. 40. So we're going to sell, in other words, short this contract, sell the 21st of February, $205 call for $5. 40. That is a basic description of the entire contract that we're getting. In other words, on 100 shares, we're being paid $540. So I really want to be clear on exactly what we're getting into here. In this case, we are accepting a payment of $540. That is the motivation to the seller.
So if you ever wondered in lessons one and two, all right, so I'm buying calls and puts, but what's in it for the other person, for the other party in this contractual exchange? Well, this is what's in it for the seller. So I'm buying calls and puts, but what's in it for the seller? They're receiving a payment. So in this case, we're receiving a theoretical premium of $540. But what's the catch? Well, for the next 31 days or through the 21st of February, someone else has the right to buy 100 shares of stock from us. And in this case, we own 100 shares of Alphabet, but they have the right to pay us $505 for those shares. That's the deal. So this is known as a short call.
Now, sometimes it's referred to as a covered call, but that really depends on the circumstances. If we own the shares, it's a covered position. So I want to put myself in the position of being the buyer of the option here for just a moment. And I want you to imagine yourself as collecting the $540 premium. So you really feel, what's going on with this contract? So here we go. So Coach Cam is about to pay you $540. You are the seller of the option because you're the one that's getting paid. But there's a, just imagine, it's not actually going to be a physical note, but let's say I'm writing out a note that says, okay, I'm going to give you $540. That's the premium. That's how much I'm paying.
But in exchange, you are promising at any time for the next 31 days, Coach Sam, Cam has the right to buy 100 shares of stock from you for $205 per share. If you agree to do that, I sign as the buyer of the option, you sign as the seller of the option. So I think it's easy to see why a trader might be motivated to do this. Hey, I get paid $540, but we need to also be aware that now for the next 31 days, entirely at the discretion of the owner of the call, we might have to deliver the shares. So why in the world would we agree to this deal? Okay. Frankie says, what determines the strike price you're selling? Is it a particular Delta or resistance on the chart?
That's a good question, Frankie. And for my example, I did go above the resistance because I want to go back to this question. Why would we even agree to this deal? Well, here's that $205 that I selected as our example strike for today. A trader who gets into this deal, who accepts that $540 premium, may actually not think that we're going to get up to $205 before the contract expires on the 21st of February. So let's kind of talk through what may happen from here and what the trader needs to be aware of as potential outcomes for this position. So how about let's talk through, maybe scenario A is just going to be the stock does what we think it's going to do. So let's talk through scenario B.
So let's say the stock goes down. This is a bearish strategy. And by the way, this is, this portion of the trade is actually a bearish strategy. Yeah. Even though we own the shares, which is bullish, selling a short call adds to this trade a bit of a bearish bias. So let's suppose the stock goes down just as we thought. Let's say that it comes down here to that $190 maybe price floor and we get to the 21st of February. Okay. So if someone has the right to buy shares from me to call away those shares is another way that we might say that. If those shares are only worth $190, even if they have the contractual right to pay us $205 for those shares, is there much motivation to do that?
Not really. They might say, and again, putting myself in those shoes, I might say, well, yeah, I know that I could buy shares from my audience member. I have a contract here. It says I can buy shares from my audience member at any time for $205. Those shares are only worth $190. I don't even care about this contract that I have. Dear audience member, at the end of this expiration, if we hit expiration here, stocks down there at $190, keep those, keep that $540 I paid you. I'm going to keep my money. I don't want to pay overpay for shares of stock. So in this case, the contract would just expire worthless with very little money. Very rare exceptions. I will say, I have to say very rare because there's still a possibility.
So could somebody get a wild hair and say, well, hey, I have the contract says I can buy the shares from me for $205. So I'm going to do it every once in a while. That actually happens. And they buy the shares. In that case, is that a negative outcome for you? You owned the shares. You own 100 shares of stock. You paid $199 for those. They're only worth $190. Along comes somebody who gets a wild hair and says, you know what? I'm going to buy them from you for $205. Okay, twist my arm. Overpay for my shares if you want to. But yeah, that's called assignment. Assignment is not always negative. And in this case, it's not very likely. In this case, most likely what happens is the contracts just expire worthless.
And so in that scenario, let's talk it all the way through mathematically. If we bought the shares at $199, and then they came down and they're worth $190. Ouch. Well, I'm upside down on my shares, but I did get the $5. 40 from the premium. So that helps. It didn't erase the loss on the stock, but maybe it just helped out a bit while the stock was waffling downward for a while. Yeah. Rick says it works for me if they want to overpay, right, Rick? Buy the shares down here. Not very likely to happen, but it's still possible. Even what we call an out of the money contract can be assigned. So we have to be aware of that.
I really want to emphasize, if these are shares that the trader absolutely does not want to lose under any circumstance, this is not the strategy for them. Because they're not in control. If we own these shares and we enter into this contract, giving someone else the right to buy our shares from us, they can do that at any time at their discretion. Even if it doesn't mathematically make sense for them to do so, sometimes they do it anyway. So that's a possible outcome. So would we call this a positive outcome or a negative outcome? Might be. Even though we're down a little bit on the stock, the trader might say, well, heck, I wanted the stock anyway. And I just wanted to get some income when I thought we were at a point where it might pull back for a while.
So the pullback isn't inherently necessarily bad because pullbacks happen as stocks are making their way up or down. But even an upward trending stock will have times when it pulls back, back, back. And at those times, that's when the trader might think about doing something like selling a call option. So that's a possibility. That's if we really understand our obligation, that's the probable outcome if the stock is down below our strike price at expiration. Well, in this case, let's also assume, let's say it goes up, but it doesn't quite get up to our strike. Let's say it's up here at $202. All right. Well, we bought the stock at $199-ish, $199. And if it's up at $202, how's the stock doing? How's our stock ownership doing?
Well, we're up, unrealized gain, about $3 on our stock. But at the same time, someone else has the right to buy shares from us on this call option, this contract that we entered into, this call that we sold. They have the right to buy shares from us. They have the right to buy shares from us. They have the right to buy shares from us for $205. Those shares are still only worth $202. So here we find ourselves on February 21st, expiration day, or any time before then, what the owner of the option that we sold might be thinking is, do I really want to pay Cameron $205 for shares that are only worth $202 or less? Probably not. In that scenario, they walk away, the contract expires.
The contract has run its course. Time's up. The other trader allows the contract to just expire worthless because there'd be no advantage for them to overpay for the shares still. And so now we're sitting on shares that are profitable, and we collected $5. 40, and that obligation has expired. So in that case, it'd be more like an $8. 50-ish unrealized gain. Well, realized on the contract, unrealized gain is a little bit more than a $8. 50-ish unrealized gain. Now, let's look at the stock. So these are a couple of sort of happy scenarios. Now, let me pull down this right side a little bit so that we can draw another line. Let's say the stock does what the trader was not expecting.
When we sold this, we thought maybe the stock was going to pull down a bit. We just wanted to collect some premium. Hopefully, that contract just expires worthless, and the premium helps us to absorb that premium. So let's say the stock does what the trader was not expecting. When we sold this, we thought maybe the stock was going to pull down a bit. We just wanted to absorb that premium. A bit of a bump along the way as our stock is working its way higher. But what if it just breaks right on through this price ceiling, it rockets on up, and it's up here at $210? This is a very different scenario. This is now what we would call in-the-money, this contract.
It's giving someone the right to buy shares from us for $205, and those shares are worth $210. So now, the potential of having to sell our shares for less than they are worth. So at expiration, what is by far the most likely outcome? Well, if somebody has the right to buy shares from us for $205, and they're worth $210, they're going to do it. As a matter of fact, any contract that's even a penny above the strike price is automatically assigned at expiration unless the owner of that contract left explicit instructions to the trader. So if somebody has the right to buy shares from us for $205, they're going to do it. As a matter of fact, any contract that's even a penny above the instructions to the trader.
So if somebody has the right to buy shares from us for $205, which is pretty rare, but left a do not exercise order with their broker to not exercise the contract. In other cases, the contracts are assigned. Yeah. So if the stock is above our strike price at expiration, we better just be planning on having those shares purchased from us. Now, notice I very carefully avoided a phrase here. Sometimes people say we're going to lose those shares if it's above $205. You don't lose the shares. The shares are sold. But what price are they sold for? Well, someone has the right to buy them from us for $205. So they buy them for $205. They pay $205. That is in addition to the $5.
40 that was already paid. This was not a down payment on the $205. It was the $205 that's in addition. So we already have $540. And then along comes the other trader and they say, hey, Cameron, I want your shares for $205. And they buy those shares for $205. So is that, that's what we call being called out. They, in the old days, we would have done this over the phone. They'd call and demand the shares for $205. Is that a disastrous outcome? Let's do the math. We bought the shares for $199.12. We sold the shares for $205. Hey, according to me, that now is a realized gain, according to my math, at least, realized gain of $5. 88.
Now, let's look at the balance on the stock trade. What about the option? Well, that we keep when the other party decides to, well actually, matter of fact, when we collect that $5. 40, nobody can take that from us. Nobody has that control. We keep that $5. 40. We might choose to exit the contract on our own. But yeah, that $5. 40 we keep and that becomes a realized gain at expiration. So, a $ 540 gain on the assignment of the contract. Also, plus that's in addition to the 588 made on the stock transaction. And we're looking at a little over $11 profit on this trade. It does mean we sold the shares. So if the trader really wanted to keep ownership of those shares, that's not the deal.
If the contract gets assigned, the shares are sold. That's something that we have to be familiar with. So that is known as a covered call. So if the stock goes up, assignment risk certainly goes up, but that's something we just have to be okay with. If the stock goes down, assignment risk goes down and approaches zero, depending on how far down it goes. But this almost starts to look like, boy, Cameron, is there any way you can lose on this trade? Of course there is. Yeah, the stock going up, we had a realized gain up. Realized gain here. In this case, what we actually had was a realized gain on the option, but we did lose some money on the stock. And in this case, it was below break even at expiration.
The worst-case scenario for covered calls is when the stock actually collapses in price. What if the stock just plummets? SquidKitty2 says, do you get the same amount of premium to get called out before expiration? This, yes. Yep. Good question. This premium is paid up front and once collected, nobody gets to take it from us. Nope. The only thing left on the table is whether or not we're required to sell the shares at 205, that's it. Okay. Well now, if you exit the option, now you said sold and I know that you're trying to learn this, we sold to get into this trade, so we would actually buy the option if we chose to get out of the trade, yeah. And that is a possibility. Okay. Okay, we'll talk about scenarios when we might do that.
But what happens here if the stock collapses in value? Let's say we bought it up here at $199. We thought it was just going to have a hiccup in its performance. We thought it was going to come down for a little while, and then it just collapses. And we hang on for dear life. And the stock goes down to, let's say, $170. Well, we bought it for up there close to $200. We're sitting underwater on the stock for $30. And in the other hand, we collected this $5-ish premium, which is a nice little consolation prize. But overall, that trade is going poorly. So this is not a strategy that one would want to employ necessarily if one really thought our stock was going to collapse.
What might be a better deal right then? What might we want to do there? Just sell the stock. If we really think the stock is just, you know, maybe we think that new management is terrible, or the potential for the sector. It's dried up, or whatever, yeah, just sell the stock. Get out. Be done. Yeah, that's what the trader would probably do there. All right, so this is our trade. And so what you may have noticed is, Cameron, is there a cap on how much we can make here? Yes. What's the maximum gain? This is one of the trade-offs for doing this strategy. It has a theoretical maximum gain for the time frame of the trade.
If this stock goes up, or if it gets called out for any reason, the most we can make, since we're required to sell the shares at 205, in this case, most we can make on the stock is $5. 88, and assuming we collect the 540 on the option, that becomes the most that can be made on this trade. Do the math with me. Is that $11. 22? Let me know if my math isn't right. I should really break out my calculator whenever there's any doubt. I'm going to do that. Let's go up here. $5. 88 on the stock. $5. 88 on the stock to the upside, plus the 540 collected on the premium, is $11. 28. There's why you get your calculator out. Yep, it's obvious. $0.
88. Anyway, so that's how much can be made. One of the nice benefits of doing a covered call position is it also lowers the break-even point on the trade net. Harlow 3,000 says, when you sell the stock, do you still keep all the premium? Yes. When you ask that question, I think when you say sell the stock, you're saying if the other party decides to buy the shares from us with the 205, what happens to the premium? At that point, whether the assignment happens at expiration or any time before, if the contract is assigned, the deal's over. That's it. Sold the shares for 205, keep the 540. This is the outcome at assignment. Maximum gain then realized. Okay? Now, that's setting commissions aside. There are commissions on options, so that can impact this a little bit.
Troy says, where did the 588 come from? It came from here, Troy. If we buy the shares for 199 and we were required to sell those shares for 205, that would be a $5. 88 profit on the stock in addition to the premium that we already collected on the option, adds up to our total maximum gain. Okay? So, one of the benefits that some traders really value with covered calls is it can lower the breakeven point of the trade. And the breakeven is equal to your purchase price of your stock, or if you want to look at it as a current price of the stock, that's another way to look at it. You know, like if we're looking at where the stock is right now, it's at $199. 66.
We bought it at $199. 12, so we're actually already profitable on this. But breakeven on the trade is actually equal to the price of the stock minus the premium. So, what does that mean? Well, if we bought the stock for 122 . 19 and we sold a call for 540, let's say the stock goes down here. Let me do a quick calculation. Did I say 122 . 19? It's 199 . 12. I'm just reversing my numbers here. We paid 199 . 12 for the stock, but then we collected $5 . 40 for the option. That means our breakeven now on this trade is 193 . 72. Let's walk through the math of that. Let's clean off all of these drawings. Let's remove this one. Let's remove this one.
Let's remove this one. And this one. See if I get the right one. Yep, it's going to be that one right there. Okay. Let's say the stock comes down. What did we say? 193 . 72. Let's say it goes down here to 193 . 72. I'm going to get it as close as I can. About there. 193 . 72. Let's say it goes down here at expiration. Well, if we just bought the stock, if we just had the stock at 199 . 12 and it went down to 193 . 72, we'd just be losing money on the stock. But in this case, we sold a call. We got that $5 . 40 of premium. If we're down here at 193 .
72 and someone has the right to buy shares from us for 205, are they going to do it? No, they're probably not going to do it. Contract just expires worthless and we keep the 540. Awesome. Realized gain on the option, but our stock lost value. How much value did it lose? Well, we bought it at $199. 12. And it's now sitting at $193. 72, we're down 540 on the stock, but we made 540 on the option. That's a break-even. Even though the stock has gone down in price, we've broken even on the trade overall. And that's one of the things that some traders really like. Now, beyond that, now we're losing more on the stock than we made on the call. And that's where we're starting to enter into loss territory.
All right. So all of these are sort of facts about selling what are called covered calls. And the reason why this way that I think about it, why is it referred to as a covered call? Well, if I own the stock and I get into a contract where somebody else has the right to buy shares from me at 205. And in the old days, they call up on the phone and say, OK, Cameron, I'm demanding those shares. I might say, hey, it's all right. I got you covered. You got the hundred shares right here. What if we don't have a hundred shares of stock? That almost sounds illegal, doesn't it? As anybody out there. Give me a yes. Yes or no. Have you thought, would this even be legal if I didn't own the shares?
Could I actually get into a contract where I'm agreeing to provide shares to someone else, but I don't actually own any shares? Yeah, that's actually referred to as a naked call. That is a call where if the other trader says, 'Hey, Cameron, I want my shares for 205.' Oh, I don't. I don't have any shares on me. What might the trader have to do at that point? They may have to go buy shares at the market price, whatever that might be, and then sell them at 205. That's actually, yeah, Eva says, 'You got to cover with extra shares.' Of course, it's legal. It is legal. It's not allowed doing what's called a naked call option, selling into a contract where we don't own the shares.
It is legal, but it's not allowed in every type. Account, for example, can't do that in an IRA. Nope. And that has to do with the fact that if we do this, Ranjeet says it may be legal, but it could be painful. How painful could it get? If I were to take this, let me just right-click on that. I'm going to copy that and I'm just going to delete it from the equation. Let's say we just did this. Now we have a naked call, but we still have an obligation to sell shares to somebody else for 205. What if the stock? What if it went rocketing up? What if we end up at $300 by the 21st of February?
And someone says, 'Hey, Cameron, that stock is looking pretty juicy to me.' It's a $300 stock and I can buy it from you for 205, so give it to me. Now, oh, I have to sell a $300 stock for $205? That's a $95 loss on the stock. What if it was a $400? That's a $195 loss on the stock. What if it's a $500? That's a $295 stock. Doing naked call options, selling into short naked call options, not a covered position, has unlimited risk potential. So for that reason, some traders are just like, 'that's off the table.' So let's put this back in. It doesn't mean that every trader says they won't do naked call options, but you definitely have to be aware of the risk.
Yeah, times 100, Kevin, exactly right. Yeah, in that extreme example that I was just providing, You know, it's at 500 bucks and we have to sell it at 205. That's $295 loss per share on 100 shares. Yep. So, yep, we're talking about covered positions in this case. I'm obligated to sell shares for 205, but I own the shares. And I own them for less than that. So there we go. So let's cover a couple of other things that traders might consider as we're, structuring this trade. Number one, what kinds of stocks might a trader choose to do this sort of a strategy on? Well, it requires stock ownership. So to put it briefly, the trader would typically do it on the kinds of stocks they don't mind owning.
So maybe in a sector that's helpful to their portfolio for diversification purposes. Maybe it's a fundamentally, in their view, healthy company, maybe showing good growth metrics, however they measure that, or value metrics. For the stock, they might also emphasize, just like we did with our other option strategies, the liquidity of the shares and the options. Lots of shares trading will tend to mean that the options also have lots of contracts trading, and that liquidity can actually help the pricing of the option. There won't be as wide of a spread between the bid price and the ask price. Shares. Share price can be a consideration. For example, in this case, buying a hundred shares just to do a covered call is about a $20,000 cost.
If it's a $500 stock, that's a $50,000 cost just to start the covered call. So that's a consideration for some traders. They might have to go lower in price in order to do this trade. Another final, not a final consideration, but another potential consideration is just what is the stock doing on a chart? If a trader is more technically oriented, what they might look for, for example, is a stock that's been going generally higher. Hopefully, it'll continue to go higher, but the timing of when to buy the stock and when to sell the call is actually quite different. So let's talk just briefly, it shouldn't take long, talk about when to enter into these kinds of trades. Well, when we're buying a stock, the phrase we've always heard is 'buy low', right?
Yeah. So maybe the trader looks to buy a stock as it's down near a price floor. With the option, with the call option, maybe they sell that when the stock is up close to a price ceiling. And you can see why here. Especially if the trader would prefer to retain ownership of the shares, they might sell that call option when they're up near a price ceiling, up near resistance. Because if the stock peels back, what does that do to the likelihood of actually being assigned on the contract, having to sell the shares? It reduces that likelihood. Ranjit says, Can you get out of the contract if things go awry? If so, how? Good question. Yeah, we're talking about entries right now. But basically buying the stock low, basically selling the call high.
All right. Now, to go to Ranjit's question, what if we do all of this work, we've seen. We've looked for stocks in a sector that looks favorable to us. We looked at a stock that has fundamentals, however we want to qualify that, that align with our investing goals. We've picked the stock with the right price for us and the right trend on the chart and has lots of liquidity. Everything seems to be lining up and we wait for price to get up to resistance and we think it's going to pull back, so we sell the call. And then the stock just continues going higher. Let's say it starts going up here. And even though we know, we've done the math on this, we know that if we get assigned, in this case, it's a profitable outcome.
But let's just say the trader would really prefer not to get assigned. Let's say the stock goes up here to 210. And for whatever reason, the other trader hasn't assigned the contract yet. So, Ranjeet. Would we say that this trade has gone awry? Well, if the objective is to retain ownership of the shares, yeah, it might be making that trader nervous. So, they might decide, you know what I'm going to do? I'm going to buy that contract back. Here's how we would do it. We'd just go buy. Oh, by the way, let's go ahead and place the original trade. Let's sell. We already own our shares of Alphabet here. I'm going to go to our 205 strike. And to sell the contract, we just click on the bid price.
Click on the bid price. That brings up an order in my portfolio to sell one contract. Check when you're doing your paper money trading. It usually defaults to 10. I change my defaults. So, we're going to do one. Let's sell that call. But just by clicking on the bid price, it's the right stock. It's the preferred strike price. It's the expiration that we've been talking about. Looks like the price of the option has actually gone up, which is kind of nice. It's up to about 570. But I'm going to quickly say that we're okay with even accepting a lower price. I'm just doing this to try to increase the likelihood of getting this order filled. Let's click confirm and send and let's sell those shares or that contract.
We're going to try to get 560 bucks out of this. We were talking about 540. We'll call it 560. We're not going to worry about this max loss because we do own the shares. But there is a commission here. Let's just send that order off and see when we get a quick fill on this trade. There it is. Sold. Sold for 570. Okay. So, what if the stock starts going up and the trader. Let's say it's up there at 210 and the trader doesn't want to get assigned. Well, they might say, you know what? I'm going to go. I sold to get into this contract. I'm going to go buy another contract in the same account. What that does is it flattens the position.
So you just go do a buy order instead of a sell order to get out. Here's the problem. If the stock's up there at 210. Since someone has the right to buy shares for 205, we might have to pay more for this contract to get out of it than we did, than we received to get into it. So there can be the loss potential. So that's if the trade is going up and going awry. Well, what if it's also, what if it's collapsing? What if the stock is going down and the trader just doesn't want to be in this deal anymore because they want to get out of the shares? Well, in that case, what they might choose to do is go buy the option back and then sell the shares.
Now, if the stock is falling in price, that means it's a less valuable contract. So we could probably buy out for less than the 540 that we received. We'd make some money on the call, but now it's time to sell the shares and might have to sell those shares at a loss more substantial than the money that we made on the call. So here's what bottom line. How might traders plan their exits? Well, if the stock is going up, if they're okay with being assigned, maybe they just say, fine, take my shares. That's my maximum gain scenario. If they want to retain the shares, they might have to pay more to get out of the contract than they received when they got into it. But it also allows them to keep shares that are appreciating.
What if the stock is going down or maybe the contract is just whittling away? Well, what a trader might do is if they've collected, let's say, 570, as we just did, if they can buy out for a fraction of that, 20% of 570 would be, just as an example, what would that be? Like $1. 14? But for some traders, they might say, well, if I can get out of my call fairly cheaply, might as well. Then I don't have this obligation anymore. And I've realized the gain on the option. So if I collected 570 and I can buy back out of that contract for some fraction, and I'm just using 20% as an example, so if I can buy out for $1. 14, maybe I'll just buy out.
And then I just own the stock and I don't have an obligation to sell it. Okay, but we'll talk about, well, I think we'll actually, I'll just say I'm going to leave it there because they're considerations. And for whether the stock is going up or whether it's going down. But guys, we've actually accomplished what I set out to do today. Now, in this example, I went to the 21st of February and sold an option there. We could have gone further out, collected a higher premium, but then we're on the hook for a longer period. I sold a 205 strike, obligating us to sell for 205. I might have gone 210, 215, 220, but the premiums shrink. The higher we are. Up we go. There's a bit of a balance the trader might want to establish.
So we just choose how much time do we want on the contract and what price are we okay with selling the shares for and is the premium adequate at that point? Guys, that's a lot, but we've accomplished selling short calls. So that's the third of our four building blocks. So we've defined a covered call. We've reviewed some important considerations and key notes. The basics for stock selection, followed the steps and placed an example-covered call trade. Next time, we're getting into the fourth building block, which is selling puts. And once we have that, trader then can start to build more complicated strategies. So everybody, thanks for giving me your time today. Time for me to let you go enjoy the rest of our educational offerings coming right up.
But as you do, just remember, if you haven't subscribed to our Trader Talks channel, please do that. You can go down and click on the subscribe button right now. It doesn't cost anything. And the YouTube channel is where you can find our playlist for previous webcasts. You can also join our live streams. Also, make sure that you're following Connie and me on X. It doesn't cost anything to give us a follow. And that's the best place to connect with your favorite presenters in between the live streams. You can find Connie there at ConnieHillCS. You can find me there at CameronMayCS. Thanks to everybody that's already clicked the like button. Over 200 people watching, 75 likes. That's always appreciated. Always. Always click on the like button if you enjoyed a webcast. It helps your presenter. And everybody, I'm going to let you go. I'll look for you in a future webcast. I'll also look for you on X. But whenever I see you again, until that moment arrives, I want to wish you the very best of luck. Happy trading. Bye-bye.
