Using Options to Distribute Stock
There are many uses for options. One application is using options to distribute stock.
In the piece Using Options to Generate Income or Lower Breakeven, we begin with an overview of covered calls and a few of their uses. To summarize, covered call writing (or selling) involves selling (to open) one call option for every 100 shares of stock that you own. The premium received by selling these options can increase the rate of return by providing immediate income on the position or serve to lower the breakeven on the stock position. However, it can also allow you to distribute stock in an efficient manner.
When you sell (write) a call against stock which you already own, you effectively agree to sell your stock at a certain agreed upon price known as the strike price. The option itself is the right for someone else to own this agreement and to buy your shares of stock at a certain price. The option buyer pays you, the covered call writer, a premium for the right, but not the obligation, to buy the shares or exercise the option on or before the expiration date (the third Friday of each month). However, if the option buyer chooses to exercise the option on or before expiration, the covered call seller must deliver 100 shares of stock for every option sold. The option buyer will in return pay you the amount of the strike price for each share.
For example, on June 1 you purchase 100 shares of stock XYZ at $50 and simultaneously sell to open one June 55 call option for a premium of $1.30. You then own the 100 shares of the security and have received $130 in option premium as the seller. This premium gets deposited to your brokerage account. If the option expires worthless (which it will as long as the stock closes at option expiration below the option's 55 strike and therefore expires out of the money), you retain the entire premium collected. However, if the stock rises above $55, there is a chance the stock can be "called away." This means that, as the call seller, you are obligated to deliver 100 shares of the equity at $55 for every option you sold. However, in a covered call, you already own 100 shares of stock for every option sold, and therefore could simply deliver those shares. Keep in mind that you are selling the stock at a $5 premium above the purchase price.
So when you purchased the stock at $50 per share and received the $1.30 to sell the 55 call, you effectively made a decision to sell or distribute the stock when it reaches $55. The premium received allows you to "get paid" for placing an order to sell your stock at a predetermined price. The only downside is that the covered call seller does not participate in any gains in the stock above 55, the strike price of the option sold.
