Foreign Investors Group

I’ve been looking at writing a covered call. If I do this and the spot price goes down I will be losing money since my stock is losing value. I will still have the premium from writing the call.

If I understand things correctly, the price of the call option will also be decreasing during this time for two reasons:

1. the call will be farther out of the money
2. the expiration date will be approaching

This means I will be able to close the option for less money than I received when writing it.

What I am wondering is if the option price ever drops fast enough that I can close the option and sell the stock before I have lost more than the premium I received from writing the option in the first place.

I am guessing this rarely happens, if ever, but I am not sure and am looking for more of an explanation of how this works.

I have read that the break-even point is
purchase price of stock – premium received

I’m not sure why I feel like there should be a break-even point slightly higher with the cost of the option figured in as well. Something like

purchase price of stock – premium received + current option price

I’m sure this all sounds silly to anyone who understands things better but please bear with me- I’m trying to learn here.

I’ll try to give an example of what I’m thinking of.

Say the purchase price of the stock was $50 and the premium was $5.

I understand that when the stock price reaches $45 that the premium is now lost. If this was expiration day it makes complete sense that this is the break-even point.

However, if it is not yet expiration day then it might cost $1 to close the position meaning that break-even would have been at $46. Yet at $46 it would have cost even more to close the position…

I’m guessing these numbers constantly chase each other. Are there any specific ways traders look at situations like these to limit their losses?

For instance, if the trade $50 purchase with $5 premium was a real trade, are there specific strategies which would suggest selling before the break-even point while closing the position instead of waiting until after the break-even point?

I’d love to see the pros and cons of doing either of those and learn more about this.

Thanks!