Hello Mark, Ditto,
I understand when a stock price hits an out of the money strike price I get called out and have to exercise.
You are under a serious misconception. When the stock 'hits an out of the money strike price' NOTHING HAPPENS. The call owner does NOT exercise the option. Why? because there is time premium remaining in the price of the option and when the call owner exercises, he loses all remaining time premium. It's far better for the call owner to sell his/her option, rather than exercise.
I also want to correct the terminology because it's important that we understand each other when talking about options. First, when you sell an option, you DO NOT have the right to exercise. The option owner has the right to exercise and thus, you do not 'have to exercise.'
Second, you do not 'get called out.' You are 'assigned an exercise notice' (or 'assigned').
What advantage does selling in the money have?
Selling an in the money option provides much more protection against a decline in the price of the stock than selling an at the money option or an out of the money option. That's the main advantage: You lose money less often and all losses are reduced. The major disadvantage is that potential profits are much more limited when you sell an in the money option.
Consider this: Above you suggested that the call owner would exercise the option as soon as the stock 'hit the strike price.' Now you want to consider selling an option that is already beyond the strike price. I hope you see that this is proof that an option owner does NOT exercise the option when the option goes in the money (moves beyond the strike price).
My take is this: It allows you to buy back the call at a cheaper price than when you sold it allowing you to make a profit correct? Then you can sell it again later as the stock price rises again.
For example, buy a stock at $40 sell the calls at $50 it goes back down to 40. I buy back before it hits 40 thinking it will go back up. I lose the stock value of $10 per share but I make a profit on the buy back of the option for a small cost. Can do this over and over assuming you buy back the call at a cheaper price correct?
I hate to say this but I believe you don't really understand how to use options. Yes you can do as you describe, but when you 'lose the stock value of $10' the profit you make when buying back the call is LESS THAN $10. This is not good for you. You could have simply sold the stock at $50 and bought at $40 and made money. In one case you make $1,000, in the other you lose money.
Your plan is not unrealistic. If you have the ability to know when the stock is going higher and when it is going lower, you have no need to trade options (at least not with the strategy you are discussing). Just buy the stock low and sell high. But, I'm sure you know it's not that easy. In fact, it's impossible for the vast majority of investors. If you have the skill to do that, then just trade and become a billionaire.
Can you also explain advantages and disadvantages are to letting a contract expire?
When you write covered calls, the optimum result occurs when the stock is above the strike price when expiration arrives, and you are assigned an exercise notice.
When the option is out of the money at expiration, then it expires worthless. The advantage is that you keep 100% of the premium you collected - and to some investors that's a great result.
But, I prefer to repurchase the call option when the price gets low (and 'low' is a relative term and depends on many factors. If you are in the habit of selling cheap options (say for $0.50 or less, then there's not much to gain by buying back early.) On the other hand, if you sell options and collect some decent cash, then it's appropriate to buy back the cheap option (perhaps at $0.05 or $0.10) and sell a new call with a longer expiration date. That allows you to bring in more cash and gain some additional protection in the event the stock declines.
As you gain experience you will understand this better.
Mark
Mark
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Mark D. Wolfinger
The Rookie's Guide to Options:
The Beginner's Handbook of Trading Equity Options