Upside Potential

Some investors want to collect time premium but also leave themselves room for capital appreciation, or upside potential. Selling out of the money calls (where the strike is higher than the current stock price) is the way to accomplish this.

For out of the money (OTM) options, upside potential is the strike price minus the current stock price. Example: XYZ stock is at $37; a call option with a strike of 40 selling for $1.90 has upside potential of $3/share (40 - 37).

For in the money (ITM) options, upside potential is zero. There isn't any. The best you can do with ITM options is collect the time premium.

There are a couple of reasons why an investor would choose an OTM option vs. the relative safety of an ITM option:

  1. You want to reduce the chances of the stock being called away.
  2. You think the stock may go up between now and option expiration, and would like to have some potential upside if it does.

While you have less downside protection with an OTM option, you do have a chance for upside potential which can make them attractive for the more risk tolerant investors.

Time premium, intrinsic value, and upside potential relate to each other like this:

Stock Price Call Strike Call Bid Time Premium Intrinsic Value Upside Potential
37.00 30
ITM 7 points
9.40 2.40
ITM: 30 + 9.40 - 37
7.00
ITM: 37 - 30
0.00
ITM
37.00 35
ITM 2 points
5.20 3.20
ITM: 35 + 5.20 - 37
2.00
ITM: 37 - 35
0.00
ITM
37.00 40
OTM 3 points
1.90 1.90
OTM: 1.90
0.00
OTM
3.00
OTM: 40 - 37
37.00 45
OTM 8 points
0.80 0.80
OTM: 0.80
0.00
OTM
8.00
OTM: 45 - 37

Note: If you want to have maximum upside potential then you don't want to use the covered call strategy. Selling a call against your stock limits your maximum upside potential to the strike price plus the time premium you receive for the option.

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