Covered Calls

[Grinder]

Mazz, if it were me I would'nt tell them as you would just end up comming off as some sort of dream crusher, instead I would direct them to the posts on this forum.

I can't comment on US ops as I have yet to venture there, the night shift is a big deterent.

 

[mazzatelli1000]

Grinder,

mate your prolly right
I had a lil verbal with some Peter Spann devotees...i got told that the pschology of trading a naked put is MILES APART from a covered call even though it is the same payoff.

I'm starting to see wealth gurus starting to spread the love about credit spreads...without mentioning the risks that is...God help some people

 

[wayneL]

Grinder,

mate your prolly right
I had a lil verbal with some Peter Spann devotees...i got told that the pschology of trading a naked put is MILES APART from a covered call even though it is the same payoff.

I really hate to support the likes of Peter Sca... ummmm, Spann, but that may be true in some circumstances.

Just like there may even be a difference in psychology between a buy/write and a covered call. Yes it is just the same strategy, but the circumstances at inception could be entirely different.

A buy/write is the simultaneous purchase of stock and writing calls over the stock.

A covered call could be the writing of calls over already existing long term holdings.

If we can assign the two different tags to two different types of trader:

The buy/writer really wants the stock to go up to get the maximum payoff, as he has entered the position speculatively to collect premium and has no intention of holding stock for the long term and wants to be assigned.

The long term holder probably won't write a call if he/she thinks the stock is going up and risk assignment, rather, he/she writes the call because the he/she thinks the stock is stagnating or going down, and takes the opportunity to squeeze some income from it.

The naked put writer is generally (but not always) analogous to the buy/writer, rather than the covered call trader, therefore the psychology entirely different.

Also the buy/writer-covered call trader may use different strikes depending on the traders psychology.

The put trader generally writes out of the money, therefore the strike is below the current price. The buy/writer-covered call trader generally writes ATM or OTM calls, therefore generally at strikes above the current price. (Though I have seen some buy/write "gurus" recommend ITM strikes)

The reasons for this may be predominantly psychological, but there are practical considerations at play as well, such as margin, risk of assignment etc.

So yes, there can be big differences in psychology.

My

 

[mazzatelli1000]

haha i agree

i didnt elaborate on the full discussion....it went something along the lines of

"you cant lose as much on covered calls as naked puts...at least with covered calls you can hold on to the shares and wait for them to go up...blah blah blah ...then the psychology"

Reminds me of the first chapter of Charles Cottle's book

Then again maybe im the blind one.......

 

[wayneL]

haha i agree

i didnt elaborate on the full discussion....it went something along the lines of

"you cant lose as much on covered calls as naked puts...at least with covered calls you can hold on to the shares and wait for them to go up...blah blah blah ...then the psychology"

Reminds me of the first chapter of Charles Cottle's book

Then again maybe im the blind one.......

Tell your mates that the naked put writer is going to end up with shares if the stock tanks, same as the buy/writer.

Then ask them which strike they will write the next call option at?

:bonk:

 

[mazzatelli1000]

Tell your mates that the naked put writer is going to end up with shares if the stock tanks, same as the buy/writer.

Then ask them which strike they will write the next call option at?

:bonk:

hahahaha

all jokes aside though, my mates are pretty convinced...emotionally invested. Theres 3 of em and their pooling a sh#$load of cash to start this, possibly getting more on the bandwagon.

Lets keep this post up there so any potentials at least have a chance to think twice

Back to OTHR

 

[wayneL]

all jokes aside though, my mates are pretty convinced...emotionally invested. Theres 3 of em and their pooling a sh#$load of cash to start this, possibly getting more on the bandwagon.

Lets keep this post up there so any potentials at least have a chance to think twice

Back to OTHR

Yep there is nothing anyone can do about this, 'cept hope they are smart enough to learn some stuff along the way.

 

[WaySolid]

Grinder,

mate your prolly right
I had a lil verbal with some Peter Spann devotees...i got told that the pschology of trading a naked put is MILES APART from a covered call even though it is the same payoff.

I'm starting to see wealth gurus starting to spread the love about credit spreads...without mentioning the risks that is...God help some people

Hey I said that. I'm no devotee of PS (though I think he's a smart guy) and would be interested why that opinion on the options needs updating?

I've never traded an option, so my understanding could be wrong and would welcome the knowledge

 

[stuart.mcclure]

I would have to dissagree with alot of the comments made up until now regarding the risk associated with covered calls, especially in comparrison to other strategies such as Bull put spreads.

Try riding through a correction with an account full of Bull Puts. Your going to be decimated. You may even go negative on your account after closing costs.

On the other side a covered call strategy will easily ride through even the worst of market corrections. Yes your account will fall in value but it would be hard to imagine it loosing more than half of its value.

The second thing to consider is the opportunity to roll. If you have ever rolled an in the money Bull put spread you will know how painfull this is. Your success rate needs to be near 90% to be successful. Alternatively rolling a naked put or call will usually result in further credits being put into your account as long as the stock is not more than roughly 10% above or below your call or put. This gives you a way out or a way to reduce your entry price or increase your exit price if the trade goes agianst you.

Thirdly, every strategy has its place you would not enter into a covered call strategy on a stock you believe is going to skyrocket. However history has shown us most stocks dont skyrocket. In fact the average yield from stocks is around 12%. Only 12% when it is relativley easy to yield 25%+pa through a covered call strategy, why would you bother sitting on a portfolio of large blue chip stock when you can sell calls on the highs and puts on the troughs to generate extra income from your portfolio. If the market rallies strongly roll up your calls to a higher strike so you still keep the majority of the gains or if the market tanks roll your puts down to a level your happy to buy. As long as your trading quality blue chip stocks that can withstand a market correction, your sure to do well out of a covered call strategy. As long as you are happy with 2-3% returns per month on your funds.

Just my 2c
I would class myself as an experienced options trader and these are the results i have found over the years. Before tearing my comments appart, consider maybe you are picking the wrong stocks if you are not finding the strategy very successful.

 

[wayneL]

I would have to dissagree with alot of the comments made up until now regarding the risk associated with covered calls, especially in comparrison to other strategies such as Bull put spreads.

Try riding through a correction with an account full of Bull Puts. Your going to be decimated. You may even go negative on your account after closing costs.

You are making the loaded assumption that a bull put trader is using the maximum position size available via margin, and therefore a thousand times bigger face value of shares than a CC trader.

Depending on your situation, that's not quite true. I have portfolio margining available to me, (SPAN) which means I can lever up CCs as much as I can lever up bull puts. Same situation if trading commodity CCs.

It also assumes the trader is stupid enough to do so. (as indeed there are) But to properly compare the risks of the two, the comparison must be made with similar bona fide money management procedures in place. This, you have not done.

On the other side a covered call strategy will easily ride through even the worst of market corrections. Yes your account will fall in value but it would be hard to imagine it loosing (sic) more than half of its value.

Not true, and the reason is contained in one of your later statements

The second thing to consider is the opportunity to roll. If you have ever rolled an in the money Bull put spread you will know how painfull this is. Your success rate needs to be near 90% to be successful. Alternatively rolling a naked put or call will usually result in further credits being put into your account as long as the stock is not more than roughly 10% above or below your call or put. This gives you a way out or a way to reduce your entry price or increase your exit price if the trade goes agianst you.

I partly agree here. One of the things I hate about OTM bull puts is the difficulty (and contest risk) of adjusting bull puts. However, rolling is not the only option and a lot depends on the strikes selected. It is possible to defend in other ways.

Thirdly, every strategy has its place you would not enter into a covered call strategy on a stock you believe is going to skyrocket. However history has shown us most stocks dont skyrocket. In fact the average yield from stocks is around 12%. Only 12% when it is relativley easy to yield 25%+pa through a covered call strategy, why would you bother sitting on a portfolio of large blue chip stock when you can sell calls on the highs and puts on the troughs to generate extra income from your portfolio. If the market rallies strongly roll up your calls to a higher strike so you still keep the majority of the gains or if the market tanks roll your puts down to a level your happy to buy. As long as your trading quality blue chip stocks that can withstand a market correction, your sure to do well out of a covered call strategy. As long as you are happy with 2-3% returns per month on your funds.

There are times and situations where CCs make a lot of sense and I fully endorse their use in those cases, but systematic buy-writing sucks in comparison to other systems.

a/ If monitoring closely for rolling opportunities, why not use the full range of option strategies available as the situation demands? ... including bull puts.

b/ The trading expertise required to turn a year in year out 25% profit (if indeed possible with systematic CC writing {and if we're being honest}) could be put to better use to make higher returns.

Just my 2c
I would class myself as an experienced options trader and these are the results i have found over the years. Before tearing my comments appart, consider maybe you are picking the wrong stocks if you are not finding the strategy very successful.

This is the best statement you've made here. Most of the CC traders I see on the Internet do precisely that, ie pick the wrong stocks (though mostly US traders). Generally, they chase bigger premium by looking for high IV situations => playing with fire.

See:

http://sigmaoptions.blogspot.com/2006/12/reasons-to-not-chase-big-cc-premium.html

http://sigmaoptions.blogspot.com/2006/12/reasons-to-not-chase-big-cc-premium_20.html

http://sigmaoptions.blogspot.com/2006/12/reasons-to-not-chase-big-cc-premium-re.html

A study done in the US (which I don't have a link for) showed that with systematic CC writing over the long term, superior returns were to be found by using stocks with the lowest IV, and therefore the lowest premiums. In other words, boring old blue chips.

It also found that CCs only outperformed buy and hold in sideways and bear markets. They underperformed buy and hold in bull markets (admittedly the study did not use rolling techniques). Over a range of market conditions, returns did not appreciably exceed buy and hold, but did reduce volatility of returns.

Traders who trade only CCs are a carpenter with only a hammer. It is only one tool that can be used. It's a good tool, but useless if you really need a saw.

Cheers

 

[mazzatelli1000]

Stuart,

At the risk of this post passing myself of as an option expert, nothing could be further from the truth. I am an amateur at this game.

I thought I'd just summarise some of the key points of this thread with some big quotes to make myself look intelligent...please everyone flame me mercilessly if too much BS appears...hhahahahaha

Thirdly, every strategy has its place you would not enter into a covered call strategy on a stock you believe is going to skyrocket

With that line you have hit the nail on the head with what this particular thread I think has been trying to get across - i.e. the myths surrounding CC's. :hammer:

1) Caveman tactics - its time for evolution
Some people (either thru insufficient knowledge...hehe like myself. .. or brainwashing) use CC's as the ONLY strategy even when the circumstances do not favour CC's or there are better alternatives.

As many other experienced traders here have alluded to, it is just one of many tools that should be in your arsenal.

There are often other risk profiles better suited to the market conditions and factors at that time. There are opportunities to make more than CC's with less capital outlay, with the same or less level of risk. Question is why wouldn't you at least consider it????

Choosing underpriced blue chips whose companies have sustainable earnings, strong operting cash flow and other industry specific factors would be smart, in this case you could be confident riding market corrections since the company you have elected has the operations and controls in place to survive the tough times. But then again im a paranoid fellow...i will come back to this in point 2 below.

Which brings us to the next point:

2) Cowboy selection and attitude
To compound the misery, some folks criteria for choosing the stock for CC's does not take into account all the risks presented by the position.
There are people who choose the stock based on the amount of premium that a particular option series presents.

E.g. Oh hey look LGL premiums are going for $1.50 per contract and the strike is $3 away from current price..... which seems pretty safe and even if it tanks a bit, it wont tank too much, the stock will survive a correction...bargain!!! Its frightening...I know of folks who do this...especially after they've heard certain option "gurus" speak.

On the other side a covered call strategy will easily ride through even the worst of market corrections. Yes your account will fall in value but it would be hard to imagine it loosing more than half of its value.

I hear lots of CC and naked put and hell even investors say this sort of thing..."it wont lose that much".

Its the glossing over this risk which is a large concern.

A few words One.Tel(gonski's), HIH (goneski's), Fortescue Metals Group (use to be $60 now $8 i believe - not exact figures but still), Allco Finance Group.

Im sure other traders will agree with me, the times when you think something isnt going to happen, it tends to happen. Risk management is the key. Again as wayneL has said, you wouldnt be putting all your money on one trade.


3) Be water my friend - Bruce Lee
What the great man is referring to is the ability to adapt to any situtation. The use of CC's or buy-writes by many are done systematically even when conditions do not favour it.

Your post seems to do a bull put spread vs. CC's with the tendency to lean towards the fact that CC's are more safer.

Which leads to the next point:

4) When things go wrong it's someone else's fault, when things go good...it was down to my genius

The second thing to consider is the opportunity to roll. If you have ever rolled an in the money Bull put spread you will know how painfull this is. Your success rate needs to be near 90% to be successful. Alternatively rolling a naked put or call will usually result in further credits being put into your account as long as the stock is not more than roughly 10% above or below your call or put. This gives you a way out or a way to reduce your entry price or increase your exit price if the trade goes agianst you.

What if it is more than 10%? this is not impossible.

You could say that with bull put/bear call spreads "as long as you roll up/down spread before it hits predetermined break even/stop loss points" you wont get decimated.

Some people are guns at managing that risk while others arent. Its the person managing the trade not the strategy that will determine if you get decimated.

In your case, it sounds like you would get decimated and then some if you were trading a bull put spread. Others wouldnt.
It sounds so trivial - manage risk, we all know we should but it doesnt get done very well.


5) One size does not fit all

As long as you are happy with 2-3% returns per month on your funds

Agreed. Everyone has their own risk/reward tolerance. Add to that amount of knowledge regarding options and that will determine what strategies you would employ.

However the concerns expressed in this post is, please do not advocate these things as a guaranteed 5% return a month, 60% return a year. Better yet, options arent a "get rich easy scheme", although some of the option guns here might disagree

Stuart, there is nothing wrong with your strategy or CC's in general. I think it hits people soft spot to read this stuff and then think " these guys are bagging out my strategy".

Lemme give you an example of an ad i saw for a bull put spread:
"How to turn 20 G's into the equivalent of $1 mill generating 10 G's in a month, and heres how to avoid losing if the share price tanks!"

No mention of Greeks -key to managing risk, no mention of possibility of loss - the rolling down and out of the spread would cover that - (the reality as you know you can get decimated), heavy marketing emphasis on returns - quoting returns on margin. Thats BS and misleading.

CC's have similar sort of marketing, except that CC's are used to cover interest payments for property investments - i have seen people sell their houses to free up money to do this sh*t. Risky or not risky??? 25% p.a. return and you choose the correct stocks, so why not eh?

Cheers

 

[stuart.mcclure]

Sorry I dont have time to fully reply to everything that has been stated due to options expiry today, however most of the things you are saying here are correct. I will add a few ways i maximise my returns from the strategy. Also covered calls are not the ultimate strategy i do also use bull puts, bear puts bull calls credit calls, callendar spreads, butterfly spreads, condors, and many other strategies. It just depends on the opportunity presented.

1. To avoid your price being more than 10% away you can do a couple of things. In volatile markets i buy protection a fair way away from my strike. effectively turning it into a wide pull put spread with far less contracts.

2. Roll early. dont wait for the trade to turn to crap before rolling a possition out and down. This means a stock must fall far further before you run into trouble. You can also roll out a few months at a time to achieve a lower strike.

3. Fortescue metals is trading at $10.63 after undergoing a stock split. It would be one of the strongest rallying stocks in the large cap end. Definately hasnt suffered a large pull back from $60 to $8

4. Covered calls do not suite every stock and are not always effective in every market. However look at OXR, LGL, BHP,RIO, or any other range bound highly volatile stock for that matter. These have been absolute fantastic.

5. Everyone seems to be concerned about capping your upside and stopping a portfolio from every really making any money. Why not use the calls to pick the peaks and sell a call only when you believe the stock is over valued and is likely to pull back. You dont have to sell a call every month if the stock is rallying.

 

[wayneL]

Let's clear something away once and for all. It's what I think we are all saying in our own various ways, and that is that in the right situation, covered calls are a fantastic strategy.

In my opinion, the right situation is on long term holdings that are not currently trending strongly higher.

I would NEVER buy stock to write a call over.

The last time I traded CCs on my own account, was on a piece of dog crap I thought I wanted to hold for the long term... that was 2 or 3 years ago now. In other words it's a very rare occurrence for me, because of the time frame I operate in.

But I run a portfolio of buy & hold, dividend paying stocks on behalf of a trust which I took over last year. It was previously in the hands of an adviser at a major broking firm. Their idea was to churn the account for as much as they could get away with.

As my remit is to generate income for the beneficiaries, I have simply written calls when I thought I could get away with it. They think I'm a wizard. In this instance they are perfect.

But lets face the reality of the covered call promotion industry. It is full of BS, nonsense, dishonesty, misrepresentation and subterfuge.

The standard line is "make 40% per year with little risk".

PFFFFFFFTTTTTT!!!!!!!! Rubbish! The sites are setup to find CC opportunities only, usually high IV situations, but ref. my links above. The wrong way to go about it.

As a "trading" vehicle, they are suboptimal. The trading expertise required to maximise profit can be better employed with other methods for superior profits.

The problem is that "options trading" is sexy and sounds fantastic at dinner table conversation... and CCs seem to be the holy grail if you swallow the hype. The thing is, it still requires some skill and knowledge (especially CGT ramifications of assignment), even for a long term b&h portfolio, otherwise they can do considerable damage. Options nooooobs are not aware of all the traps (because the sheisters usually don't teach them).

Anyway, enough ranting for now.

 

[sails]

Sorry I dont have time to fully reply to everything that has been stated due to options expiry today,....

Hi Stuart,

I pretty much started my options career with covered calls around 5 years ago after going to a seminar where they recommended leveraging as high as possible with margin lending to purchase shares for the sole purpose of selling covered calls. Oh, and the fees for purchasing the shares were a hefty 1% with the seminar spruiker supposedly getting 50% of the loot.

After a heart stopping couple of months with wild swings in NCP (NWS now), I closed all positions and settled down to learning about options properly and also found a more reasonably priced broker. I now mainly trade in spreads - eg butterflies, calendars.

With the benefit of hindsight and a fair bit of option trading experience, I do agree with the concept that CCs have their place especially in a portfolio which one already owns - or plans to buy and hold. Selling puts to purchase the shares and then selling calls over them can be a good strategy under those circumstances.

Anyway, that's my experience with CCs - but I do have a question for you. Recently I was running some simulations in excel mainly on the Oz banks and BHP to find the optimal time to roll a short option. I was initially taught to let it go to expiry day to squeeze the last few cents out of the short, however, my findings quite consistently showed that it was better to roll no later than the Monday before expiry Thursday. It appears that premiums in the next month become quite deflated in those last few days and there was a higher premium loss in the next month than in the front month.

Of course, a rise in volatility generally improved the odds of waiting until expiry day.

Do you normally wait until expiry day to roll the shorts - or have you also found it an advantage to roll a few days early?

Cheers

 

[wunglung]

CC's are great!

My solution to getting caught in a strong upward trending stock and going in the money on my sold call is to firstly admit that I am a fool for partaking in such a stupid trade, once I do this and stop crying and pull myself together I consult the charts closely and sell the stock at or near the peak (takes skill, but acheivable). This means you go naked (takes balls and confidence to this, amateurs should never do this if they dont understand the consequences) and then as the stock falls back you either buy the stock back or close out the sold call position. If you cant sleep at night knowing that you are naked then you can buy some cheap protection (buy high strike call to cover sold position).

 

[wayneL]

CC's are great!

My solution to getting caught in a strong upward trending stock and going in the money on my sold call is to firstly admit that I am a fool for partaking in such a stupid trade, once I do this and stop crying and pull myself together I consult the charts closely and sell the stock at or near the peak (takes skill, but acheivable). This means you go naked (takes balls and confidence to this, amateurs should never do this if they dont understand the consequences) and then as the stock falls back you either buy the stock back or close out the sold call position. If you cant sleep at night knowing that you are naked then you can buy some cheap protection (buy high strike call to cover sold position).

Let me get this straight;

1/ You make a maximum profit, yet it's a stupid trade and you're crying about it.

2/ You then become an ace technical analyst by picking the precise top, after have failed to see the coming upswing.

3/ Then flip the trade from a synthetic short put to the natural short call with almost zero extrinsic value and delta close to -1, thereby taking on more delta exposure than the original trade.

hmmmm.

 

[mazzatelli1000]

3. Fortescue metals is trading at $10.63 after undergoing a stock split. It would be one of the strongest rallying stocks in the large cap end. Definately hasnt suffered a large pull back from $60 to $8.

My mistake ladies and gents...quoted the wrong stock
(nervous laughter)...thats a worry

4. Covered calls do not suite every stock and are not always effective in every market. However look at OXR, LGL, BHP,RIO, or any other range bound highly volatile stock for that matter. These have been absolute fantastic.

BHP

OXR :

 

[jayinoz]

I started writing options a year ago and it was a better move than if I held my portfolio & left it. After making approx 30% the previous year...I got a scare with Centro but got out with a low stop loss.

Having a portfolio of more weighted materials\energy and some financials I had mixed success...

From the 50+ option writes I made approx 3% pm. Always getting a good premium for writing at the money. However offset my portfolio with a 12% loss and it equals 18% up for the year- yes I know in a bear market the last financial year. Yet it was lucky timing for preservation of gaining positive interest, all up.

It not so exciting as picking a short\long call\put yet it can give some protection, and some protection is better than none. This next year I will write a few on stocks I wish to keep then take a little more risk with some other strategies. I will stick to energy then in time hope to pick the time that financials bottoms out.

PLUS you get far better premiums for writing covered calls than you did a year ago. As volitility in the markets suites the option\put pro.

I have known some guys who take out a put + call option on same stock and seem to always make a buck. Then again nearly everyone wants to tell u about their winners & not their losses. Lucky year in the worst stock market year to date for 26 years. Covered calls will need to be apart of my upcoming years strategy for Rio BHP and the more stable stocks. Use the volitile stocks for your option guesses.

 

[Vondelpark]

Hi Jay,

Interesting stuff. I had extensive experience with options overseas but not in the domestic Australian market. I think having options excercisable into 1000 stock is crazy, and definitely stifles the Australian market greatly.

If you don't mind me asking - are you writing calls on long stock you fully own, or margin lending to get hold of the underlying and using the same brokerage to be able to short those calls against it?

I do not have extensive domestic share portfolio as I simply do not want to tie up the cash but I wouldn't mind the scenario where I could long CFD's and write calls against those positions. Does it exist? It may well do but I am not aware of it.

Another thing - what kind of strategy do you employ now that equities got belted? I guess we are going to see bounces and while IV is high (and it is a great time to slot that premium) sharp rallies I would think could cost you if they are too close to the ATM.

Thanks for letting us know how your strategy went.

VP

 

[clayton4115]

hi

can you write CC on the index? can you explain to me how i would do it? i have $10,000 which i would like to start CC on the Index (ASX200).

thanks