One of the most important -- and enjoyable -- aspects of trading options is the calculation of your profit. To estimate the move needed from the underlying stock for a profitable options trade, it's important to understand the concept of intrinsic value. Only in-the-money options have intrinsic value, which is the difference between the option's strike price and the current market price of the underlying equity. In other words, the closer the option gets to expiration, the more its value is attributed to intrinsic value.
At expiration, all of the option's worth comes from intrinsic value, since there is no time value left at expiration. In this example, if ZYX advances by at least 6 points, you will likely make money on the call purchase. Now, suppose XYZ Corp. The remaining 5 points 10 minus 5 of its premium is attributable to time value, which declines as the option approaches expiration. Once again, the closer the option gets to expiration, the more its value is attributed to intrinsic value.
In this example, if XYZ declines by at least 5 points, you will likely make money on the put purchase. Covered call writing is different from straight call and put purchases because it involves the combination of a stock position and a sold out-of-the-money call. In fact, the underlying equity doesn't need to move at all in order to make money on a covered call, since the seller gets to pocket the premium as long as the stock remains beneath the call strike through expiration. Schaeffer's Investment Research Inc.
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