# Regarding tradean/covered calls



## wayneL (17 January 2005)

I thought I open a new thread about some of the issues tradean has brought up in the CFD thread, and post here rather than that thread getting off track.

Firstly, tradean, we traders and investors tend to have very robust conversations. Sometimes they get out of hand. But it is through these conversations (arguments LOL) that we learn really useful things. I've learned heaps through bickering with the likes of Tech/A, Crashy and others. I sure it is likewise for them. But we are all friends in the end cause we all keep sharing good information.

Those who do get spooked by these "conversations" probably should not be trading. Thats not to denigrate anyone, but there is a certain psychology required to do this successfully. Perhaps that something is what makes these interesting debates.

That said, this particular forum is THE politest of them all, and we all try to keep it that way.

Covered Calls:

These have been promoted as a no lose, cash flow panacea by certain "wealth educators" and been given fancy nom de plumes like "share renting" amongst others.

I had a heated "discussion" next door at PI.com when someone stated it was easy to AVERAGE 4% per month by writing covered calls.

The reality is far different and this is not achievable over the long term writing covered calls.

They do have their place and are very useful under certain circumstances. But, as a trading strategy, there are far less capital intensive and less risky option strategy alternatives.

I believe the problem is this:

People pay thousands of $$$$$$ to learn something at a seminar, that can be described in a few paragraphs in any decent book. So  the "emotional investment" can be very high.

Very often this causes us to defend the concept we have learned about without due reference to the real facts...facts that the wealth educator neglected to point out.

Lets look at an example:

The stock below is Cree research. Imagine buying 1000 stock on the 21st Dec for $38.55 and writing 10 Jan $40 call contracts for $1.48

This means you have spent $38550 on the stock and collected $1480 in premium.

At the close of trading on friday your written call contracts are worth almost zero and it is almost certain they will expire out of the money this friday...nice! collect $1480

But or stock is now only worth $25880. A loss of $12670.

This means we are behind by $11,190!!!!!!!! and a hell of a long way behind our average 4% per month.

Now if you really like cree reasearh as an investment and always owned them and want to keep them despite the gap down, then fine. You have made a few extra bucks income.

But if you bought CREE just so you could write a call then this is a serious kick in the arse.

Hope that helps


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## tech/a (17 January 2005)

*Re: tradean/covered calls*

Love it!

Ive seen some intelligent people actually believe that this is a hedging stratagy!

Wayne.
Its an extreme example but valid.
Writing calls should in my veiw be during a period of sideways/correctional movement where your holding for long term.Short term only.
I know of a guy who wrote naked index options 30 days out simply to collect premium.Did pretty well.(On the FTSE).

Options trading is an art.Those who buy and write without stratagy are market fodder.Of all the numbers games in town this is for the Card Counters.
To the pro an options trade stands out like a beakon.

tech


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## positivecashflow (17 January 2005)

*Re: tradean/covered calls*

Hi WayneL,

Interesting that you talk about CREE! When it gapped down, IV spiked so I think now is an opportune time for credit type strategies, maybe even a cheap calendar spread... (haven't found one I liked yet though!) just look at the volatility skew!


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## wayneL (17 January 2005)

*Re: tradean/covered calls*

Actually pos,

I wouldn't mind a few CREE for the bottom drawer. So I wrote some Jan puts friday arvo, and won't mind being exersized. Otherwise a bit of nice premium to keep on friday.

But agree with you...opportunity here. 

I sure do like those IV charts, must do something about that soon.


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## positivecashflow (17 January 2005)

*Re: tradean/covered calls*

Lets keep it simple,

How about some CREE Mar 22.50 Puts for 90 cents?  Any takers?  LOL


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## JetDollars (21 January 2005)

*Re: tradean/covered calls*

I wrote covered calls in the last 3 months with Aussie Stocks. It was profit for the first month. I was too confidence that I pick the right stock, therefore, I did not take any put to cover the down trend. Then Sh** happen, the second month I got hammer. The stock keep going down and break the resistance ie. my exit point. I bought back the call and sell the shares.

Then I bought back the shares and write a new covered calls. But what I should do back then is to rolldown instead of sell the shares.

Since then the stock been trading sideway. Currently I am still have a calender spread and bull call spread open because I believe the shares will trade around $1.18-$1.20 in the end of Feb'05.

The stock I am talking about is


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## wayneL (22 January 2005)

*Re: tradean/covered calls*

Update on CREE:

My written Jan $25 puts will expire in the money so it looks like I'll be assigned some stock. Should be about squits on Monday open as I morphed it to a calander spread that had me hedged to about 23.5...we'll close around that figure tonight.

Cheers


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## positivecashflow (22 January 2005)

*Re: tradean/covered calls*



			
				positivecashflow said:
			
		

> Lets keep it simple,
> 
> How about some CREE Mar 22.50 Puts for 90 cents?  Any takers?  LOL




These puts are now worth $1.30, which is a 44% ROI if you sold it on Friday. Not bad for a 4 day trade.  (I didn't take this trade though.)

WayneL,  

I thought you were happy to be assigned the stock?


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## wayneL (23 January 2005)

*Re: tradean/covered calls*

Pos,

Yep, Happy to be in the stock. Just not happy to be in a $23.50 stock with an effective buy price of $24.40. So just trying to lower my effective buy price, cause who knows where this sucker is gonna stop.

Scrip goes in the bottom drawer, but option plays will protect value until an uptrend resumes.


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## wayneL (25 January 2005)

*Re: tradean/covered calls*

CREE:

Position now synthetically a put backspread...hoping now for further downside.

You can't take take the trader out of the boy that fast LOL


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## DTM (25 January 2005)

*Re: tradean/covered calls*

CREE:  

I think this sucker's near the bottom and may bounce up again soon.  On the hourly charts, the rate of descent has slowed down and looks set to go up again, soon.


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## wayneL (25 January 2005)

*Re: tradean/covered calls*

Yes Dt,

It looks as though it may have touched the bottom of the pool.


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## wayneL (26 January 2005)

*Re: tradean/covered calls*



			
				DTM said:
			
		

> CREE:
> 
> I think this sucker's near the bottom and may bounce up again soon.  On the hourly charts, the rate of descent has slowed down and looks set to go up again, soon.




Yup,

A quick metamorphisis was in order early in the session.


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## Cosmos (26 January 2005)

*Re: tradean/covered calls*

With regards to the courses/wealth creators I do agree fully with your arguments but you have taken a few points out of context.

People who claim to preach wealth creation show strategies people can use to create wealth over the longer term and not swing from position to position.

Lets take for example the DJIA and treat it as a stock, 1960 it is at 600 points or $600 (we will use 1960 for the example as this wealth creator plans on retiring soon in 2005).

In 1960 he brought $20'000 of DJIA stock and lets say no dividens where received and he made 5% per year writing calls and each year the profit from this would be invested back into DJIA.

Now if we were to sell and cash in today DJIA would have gone up on average 36.6% per year ((((10'500-600)/600)*100)/45),

These means that after 45 years our investor would have $88'677'439'206 in wealth, not bad eh! Or stock the DJIA did go up by this much and if you could write calls you would have made this much. The progression for anyone that is interested is as follows:

20,000
28,320
40,101
56,783
80,405
113,853
161,217
228,283
323,248
457,719
648,131
917,753
1,299,538
1,840,146
2,605,647
3,689,596
5,224,468
7,397,846
10,475,350
14,833,096
21,003,664
29,741,188
42,113,523
59,632,748
84,439,971
119,566,999
169,306,871
239,738,529
339,469,757
480,689,176
680,655,873
963,808,716
1,364,753,142
1,932,490,450
2,736,406,477
3,874,751,571
5,486,648,225
7,769,093,886
11,001,036,943
15,577,468,311
22,057,695,129
31,233,696,303
44,226,913,964
62,625,310,174
88,677,439,206

Even if we only put 5000 in for a 15% return (half of what the DJI has averaged) we would have this:

20,000
21,000
22,050
23,153
24,310
25,526
26,802
28,142
29,549
31,027
32,578
34,207
35,917
37,713
39,599
41,579
43,657
45,840
48,132
50,539
53,066
55,719
58,505
61,430
64,502
67,727
71,113
74,669
78,403
82,323
86,439
90,761
95,299
100,064
105,067
110,320
115,836
121,628
127,710
134,095
140,800
147,840
155,232
162,993
171,143


Cheers


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## wayneL (26 January 2005)

*Re: tradean/covered calls*

Sorry Cos,

In no way is it as simplistic as that. I will bet my bottom dollar that many investers actually end up LOSING via covered calls.

Covered calls are great in certain circumstances, but, are an inadequate hedge (if a hedge at all )in down months and you will lose your stock in up months, limiting profit...unless defensive strategies are undertaken. (beyond the capabilities of the great bulk of investors).

Most "investors" would be better of staying well away.

Also your above figures are not clear. How did you arrive at 36% profit compounding with the covered call strategy? One minute you are talking 5% per year then 36%??????????

These strategies (covered calls & naked puts) that are promoted by "wealth seminars" sound very clever and sophisticated...attractive to the ego. Very few have the expertise to pull it off to satisfaction, as is evidenced by the number of people who USED TO do covered calls.

Cheers


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## Bingo (26 January 2005)

*Re: tradean/covered calls*

Must agree. My experience is exactly what you say. Stock is lost in up periods and your cash is tied up until they exercise and take the stock. If you buy back the option at a loss and then the stock falls you could even make a loss on the stock as well.

I find trading options is a tricky business, however, a reasonable profit can be made is option strategies are selected based on a reasonably accurate view of the market trend.

I must say that I remember a period of sideways movement in the market (would need to look up when it occurred) when writing OTM calls against stock holdings was a very profitable strategy. Basically no capital gain but dividend and call option income. It is one of the few strategies that works well in a sideways market.

Bingo


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## Cosmos (26 January 2005)

*Re: tradean/covered calls*

Waynel,

The 36% is the annual growth rate of the DJIA for that period and the 5% is the amount we could have made in theory if we where to write calls, I hope that is clear now but I think you understood this in the first place.   

Now we are talking about 5% a year, not a month, taking a cautious approach to doing the call writing can easily achieve. I hope we also have forgotten that even if the strike price was met we can still roll up and get out just fine.

All I wanted to prove is the strategies people preach are often educated and as you have seen in recent times it would have worked just fine. Even making it more real life, if you had done the same with MCD (Macdonalds) from 1971 or K (Kellogs) since 71 as well, your money would *have been 10 times that of the DJIA example*  so it works and it works in real life and this I have proven using real examples your could have done then and the same examples apply today.

Cheers


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## wayneL (26 January 2005)

*Re: tradean/covered calls*

Your maths still don't add up to me. How does 5% p/a turn into 36% p/a compounded?

It also presumes a perfect linear equity curve which we all know is not realistic. It does not allow for assignments or taxation... taxable events will occur when you are exersized.

My point is that CCs are not a one size fits all strategy, as presented by the wealth seminar clowns. There are periods when they are contraindicated, and other strategies should be employed.

Cheers


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## Cosmos (26 January 2005)

*Re: tradean/covered calls*

You are correct in saying that one size does not fit all by these clowns and most of them are clowns, I do agree.

The 5% does not turn into 36%. 5%pa is the profit from writing the option and the 36% is from the price of the DJIA rising i.e going from 600 points to 10'500 points or growth. We then reinvest the 5% in each year.

Cheers


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## Bingo (27 January 2005)

*Re: tradean/covered calls*

Cosmos,

If you get a 36% increase from the marklet going up then the 5% from options  is a small component.

It would seem that if these are the numbers you are using then the option is not worth while because of the risk of exercise and loss of stock is greated than the 5%.

Bingo


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## DTM (27 January 2005)

*Re: tradean/covered calls*



			
				wayneL said:
			
		

> CREE:
> 
> Position now synthetically a put backspread...hoping now for further downside.
> 
> You can't take take the trader out of the boy that fast LOL





Wayne,

I think its got further to drop.


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