Opportunity Lost

Grasshopper, make sure you understand what a Strike Price is before you read this section. You must understand Strike Price to understand Opportunity Lost. “Opportunity Lost” is one of those subjects where the page is under both “Educational” and “Philosophy, Strategy and Risk.” It’s a term that should be defined and understood so I have it in “Educational” and it has to do with strategy and risk so it’s also in “Philosophy, Strategy and Risk.” “Opportunity Lost” is the profit you don’t realize when you put a limit on the upside gain of the underlying stock when you sell a Covered Call.

If you read “My Philosophy & Strategy” you know I’m not a big fan of owning stock, especially short term. Although, at times, I must own stock to cover positions or just because a stock is moving so well It’s very tempting and hard to avoid. Not too often do I own stock short term and not have options involved. I am in this game to SELL options and bring in money. I have a strategy and I stay very disciplined. I find, after many years of doing this, I am very successful doing what I do. I don’t buy options….often, I don’t buy Puts….often, I very seldom sell Puts. I’m not that trader holding 10 stocks where 5 go up and 5 go down, and you end up losing money. As I’ve said and will say many times, you can take 10 investors with 10 different strategies and possibly all make money. I’m not knocking other strategies; I can only teach my strategies & philosophies and show my results…..Let’s get into “Opportunity Lost.” When it comes to “Opportunity Lost” I might go against what Wall Street investors believe but I live on Main Street.

Do we have risk in writing Calls on stock (Covered Call) we own? Well, yes, and it needs some consideration. The risk I talk about is different than what most books will tell you. The risk I consider is the risk of your stock going down. The books and Wall Street investors do not even consider this a risk. They consider the “Opportunity Lost” a risk with Covered Calls. Since I don’t like owning stock, the Covered Call is not my favorite strategy. Do I do them? Yes. Sometimes I do find a good situation to do a “Buy-Write” but most of the time I start with a Naked Call and if I have to cover it (buy the stock), it becomes a Covered Call. If not, I never buy the stock. This is explained in “My Philosophy & Strategy.”

If I sell a Covered Call, I create a situation where double-digit returns are certain, regardless of outcome, and in exchange I accept the lost opportunity risk.

Example: You buy 1000 shares of XYZ Corp at $20 a share, sell 10 contracts of the $22 Call Option one month out, and bring in a $1 premium ($1000). Regardless of where the stock price goes you keep the $1000. Lets examine some possible outcomes.

1. At expiration XYZ Corp is $25 – You lose (sell) your stock at $22. You have a $3 Opportunity Lost on the stock. You keep your $1 premium. Total profit is $3000 ($2000 gain on the stock and $1000 premium).
2. At expiration XYZ Corp is $15 – You keep your stock. You keep the $1000 premium.

When this Covered Call was sold you accepted the chance of losing profit above $22. In example 1, the stock went to $25 and you have an Opportunity Lost. You lost the opportunity to make the extra $3 because you sold the Call with the Strike Price of $22. If you never sold the Call, your profit would not be limited at $22. Since you sold the Call, you are obligated to sell your stock at $22. You get the profit up to where you placed the Strike Price, but above $22, the buyer of your option gets the profit. That’s what he paid you the premium for. When he paid the premium he felt the stock was going higher than $22. It worked out for him and you made a $3000 profit. I look at this as both players did nicely.

In example 2, the stock went down to $15. The buyer of your option is not going to exercise he’s option and buy the stock at $22 because he can buy it on the open market at $15. So you keep the stock and keep the $1000 premium. Where is the risk in this Covered Call strategy? Is it in the Opportunity Lost risk from the stock going up and you missing some profit OR is it the risk of the stock going down and you not being able to sell because of the Call you sold? I think the risk of Covered Calls is the stock going down. You will read more about this in “My Philosophy and Strategy” under “Philosophy, Strategy and Risk.”

After reading “My Philosophy & Strategy” you will know I don’t like owning stock! I always feel there is a higher chance of the market going down 500 points than going up 500 points. When it comes to Opportunity lost, my philosophy is, know what it is, know what the term means, but I don’t worry about the Opportunity Lost. A trader can only know in hindsight if a stock is going up. If we know, with 100% certainty, a stock is going up and staying up, we would not have to sell Covered Calls and worry about Opportunity Lost. Since we don’t have a stock market crystal ball, we have to pick our strategies, philosophies and motivations according to our own risk tolerance. With Covered Calls, my risk is in the stock going down.  If I come out of a trade making money, I’m happy! I don’t worry about what I could have made. With options the potential for loss, if not disciplined, is great. A winning trade is a winning trade! I’ll take profit and move on to the next deal. No trader ever went broke taking profit!