Once again there's been a lot of discussion on the JustCoveredCalls Yahoo group on the equivalence of ITM CC's vs OTM CSP's, so I decided to provide a "real life" example to show that these are truely equivalent positions. The stock, Aeropostale (ARO), was chosen at random and an ITM CC and OTM CSP was established today.
As you should be aware, option premium consists of intrinsic value (the difference between the stock price and the ITM strike price) and extrinsic value (sometimes referred to as time value). An OTM put has all extrinsic value, whereas an ITM call has both intrinsic and extrinsic value. Due to put/call parity, the extrinsic value of an ITM call and OTM put at the same strike/expiration should be equivalent. Extrinsic value is your income or profit, whereas intrinsic value is Return of Capital, or put another way, a refund or rebate on your investment. It's like going to the store with $20, buying a $20 product, and getting a $5 instant rebate. You actually paid $15 for the product and have $5 of your original $20 back in your hand. You didn't earn $5, you saved $5.
In the CC example below, you'll see that the call premium was split into two columns. The intrinsic value in the Stock Investment column, reducing the cost basis to the strike price of the call, and the extrinsic value in the Income Generated column. The $120.00 intrinsic value is back into the account, available for reinvestment, and is no longer part of the CC position. When accounting for it in this manner, the cost basis of the CC becomes the same as the cost basis of the CSP, which is the strike price, and the extrinsic value represents the true income generated, making it easier for comparison.
Below are the details of both positions. I'll provide ongoing updates as the positions are managed.
CC Position Summary
Aeropostale (ARO). All prices include IB commissions.
| Cost Basis | ($1,200.00) |
| Income Generated | $14.52 |
| Percent Income Generated | 1.21% |
| Annualized Income Generated | 20.08% |
| Net Profit If Successful | $14.52 |
| Percent Return If Successful | 1.21% |
| Annualized Return If Successful | 20.08% |
| Days Held to Expiration | 22 days |
Trade History
| Date | Stock | Description | Transaction | Status | Stock Investment | Income Generated |
|---|---|---|---|---|---|---|
| 11/29/2012 | ARO | Initial Stock Position | BTO 100 ARO @ 13.20 | ($1,320.00) | ||
| 11/29/2012 | ARO | Initial Call Option | STO 1 Dec12 12.00 Call @ 1.35 | $120.00 | $14.52 | |
| 12/21/2012 | ARO | Totals | ($1,200.00) | $14.52 | ||
| DTE | 22 | Percent Income/Annualized | 1.21% | 20.08% |
CSP Position Summary
Aeropostale (ARO). All prices include IB commissions.
| Cost Basis | ($1,200.00) |
| Income Generated | $14.12 |
| Percent Income Generated | 1.18% |
| Annualized Income Generated | 19.52% |
| Net Profit If Successful | $14.12 |
| Percent Return If Successful | 1.18% |
| Annualized Return If Successful | 19.52% |
| Days Held to Expiration | 22 days |
Trade History
| Date | Stock | Description | Transaction | Status | Stock Investment | Income Generated |
|---|---|---|---|---|---|---|
| 11/29/2012 | ARO | CSP Margin Used | BTO 100 ARO @ 12.00 | ($1,200.00) | ||
| 11/29/2012 | ARO | Initial Put Option | STO 1 Dec12 12.00 Put @ 0.14 | $14.12 | ||
| 12/21/2012 | ARO | Totals | ($1,200.00) | $14.12 | ||
| DTE | 22 | Percent Income/Annualized | 1.18% | 19.52% |
