Question: Mike - I enjoyed reading your series of articles on covered calls. I have a question. I recently put on a covered call position against my 500 shares of Apple (AAPL) when it was trading at $65. I sold the August $70 call for $.90. It looks like it's going to expire worthless. Now what? - Alex B, Indianapolis, IN

Answer: Alex, there are a few issues we need to address. At this writing, AAPL is trading at $68.13. You have some questions to answer on your way to making a decision. Let's assume AAPL closes at $68.13. Your current situation is:

a) A profit on your 500 AAPL shares of $3.13 ($1,568) - if you were to sell your shares.

b) A profit from the premium you took in of $450 ($.90 x 500)

c) If you sell your shares at $68.13, you'll have a total profit of $2,018

Now, the questions are:

1) How do you feel about AAPL? Are you still bullish?

2) How far up can AAPL go before it meets significant resistance? (Yes, that means you'll actually have to look at a chart)

3) How much premium can you take in selling the September $70 call?

4) How much premium can you take in selling the September $72.50 call?

5) How much premium can you take in selling the September $75.00 call?

Take a look at an AAPL chart and then the option chain below.

If you're still bullish on AAPL, items to consider are:

1) Some resistance exists at about $70. Stronger resistance exists at about $72.00.

2) If you sell the $70 call, you'd take in $1.80 of premium (top red arrow). So, your potential profit would be $700 ($1.80 x 5 contracts) plus $935 ($1.87 x 500) from stock appreciation. Total: $1,635.

3) If you sell the $72.50 call, you'd take in $1.00 of premium (top blue arrow). So, your potential profit would be $500 ($1.00 x 5 contracts) plus $2,185 ($4.37 x 500) from stock appreciation. Total: $2,685.

4. If you sell the $75.00 call, you'd take in $.50 of premium (bottom red arrow). So your profit potential would be $250 ($.50 x 5 contracts) plus $3,435 ($6.87 x 500). Total: $3,685.

Now, choice #3 looks pretty good. But, what's the likelihood of AAPL going through two resistance levels to above $75? It certainly is possible. AAPL has done it before, but the idea is that we want to put ourselves into a position to profit - but without asking the stock to do too much. That's why I personally like choice #2 - taking in reasonable premium and giving AAPL a fighting chance of getting up to the short strike ($72.50). However, the choice is yours.

If you are VERY bullish on AAPL, and don't want to cap the profit potential of your 500 shares, you can sell calls on just 300 shares and leave the other 200 shares free to run to the moon. Obviously, you can choose whatever ratio of shares you want.

If you are no longer bullish on AAPL, get the heck out of Dodge with your pockets full of money. Dodge is a dangerous place. A lot of those cowboys never got out alive. And you DON'T want to be a cowboy. Why do you think they are almost extinct?

Alex, You Got Lucky

You said you read the columns on covered calls. You must have missed, or ignored the part about protecting the downside. Covered calls are dangerous. They have the same risk as if you sold a naked put. Your asset had a value of $32,500 when you sold your covered call. You were exposed for the entire $32,500 less the $500 you received for selling the original call.

What would have happened if bad news came out and AAPL would have gone down to $51? It was at that level in mid-July. The question is whether or not you will have the self-discipline to close out your position before it reaches that level. Some traders do. Most don't. They're sitting and puffing on that "hopium" pipe - hoping that the stock will come back. That's not a way to run a business - and trading is a business - at least until you lose your entire inventory (money).

As an example, you could protect your investment by buying a January 2008 $65 LEAPS put for about $9.00. Sounds like a lot of money, but if you prorate it, it's not so bad. You'll have protection for 17 months. The prorated cost of this insurance is only $.53/share/month. You would be protected from a catastrophic event from $65 down to zero. You don't have to worry about gap-downs.

You would be exposed for the $3.13/share difference from where AAPL is currently trading ($68.13) and $65 - when the insurance put kicks in. It's like an insurance deductible. You can buy a $70 put, but the better insurance you buy, the more it costs.

Some traders believe that stop loss orders will take care of the risk. But, a stop loss order on a gap down can result in you taking a huge loss. We'll spend some time in upcoming columns examining how the various "stop loss" orders work as well as the positive and negative aspects of each.

There sure are a lot of things to think about, aren't there? There are if you want to position yourself to make money. Keep in mind that you're trading against professionals. They can smell fresh (trader) meat and they salivate at the thought. But, I suspect you'd rather keep the money in your pockets rather than your dollars paying for a new Hummer for the market makers. That's why you need to continue learning - and understanding the "complete" thought process for each strategy.

Mike Parnos is an options instructor and mentor.  Online Trading Academy trading knowledge...your most valuable form of capital.