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Alice has held 1,000 shares of AT&T stock for 30 years. Her basis is $5 a share and AT&T is currently trading for $35 a share. In a time of market turmoil like the recent financial crisis, Alice is concerned that the stock may decline significantly. She does not want to sell the stock because she likes getting the dividend. So she buys a put with a strike price of $25 a share.
Fred buys one share of Intel stock for $20. After holding the Intel stock for 3 months and at a time when Intel is trading at $25, Fred writes a 60-day, $30 call for $2 to generate some additional income. Assume that the option expires worthless after 60 days and that Intel is trading for $26 when the option expires.
Sticking with Fred, assume that one month later, Intel has declined from $26 to $22. Fred now writes a 31-day, $25 call for $1. Assume that after 31 days, the call expires and Intel is trading at $19.
Two months later, when Intel is trading at $15 a share, Fred writes a 45-day $20 call for $2. On the expiration date, when Intel is trading for $25 a share, Fred is assigned on the call. At this time, the call is worth $5. Fred delivers his Intel stock and receives the exercise price of $20.
Ex. 2 $2 short-term gain on call
Ex. 3 $1 short-term gain on call
Ex. 4 $2 short-term gain on stock
Total: $5 short-term gain