Writing Covered Calls

[mazzatelli]

Put it this way. I believe it works for me and factually it has. Fluke or Fact, either way I enjoying doing it.

It is sad that alot of people seem to believe that that being smart equals making profits. See, I'm smart to know that it is not true.
fyi, the trade in question ended up being profitable

The second quote isn't attributed to you, but to a former member on the forum. They played against upside dgamma curvature - funnily enough made money for many months, before a large hit took out their account.

Whether intentional or not, I find it "ingenius" that seminar clowns have latched onto a strategy that can give someone a nice run of wins - providing false confidence . When the big hit comes - they put it down to "poor risk management" on the practitioners part.

It's a pity, Wayne & sails have explained and dissected the topic so many times - people either don't understand or don't want to.

 

[BrightGreenGlow]

This is true...

However. How do I whipe out my account if I only use covered calls?

I collect dividends, collect a premium and sometimes I have to sell my shares at a lower price. Therefore, yes I could be making more money, however I enjoy $500 a month and like holding the shares like ANZ/BHP that I do calls with.

Sure selling and buying at the correct times may be more profitable but I'll never be in the position of owing people money. I'll only ever limit my profit.

I understand their points of view also and value them. This is my style of trading and I like it.

 

[nunthewiser]

Can you give me step by step instructions on where i start in this method if i hold bluechip shares John , as in who do i call ? how do i write such a thing? where do i get my profits from , who do i pay if it goes wrong etc ? what brokers offer this service etc etc ?

I trade other instruments not actual options so am genuninly intrested in other methods

 

[BrightGreenGlow]

I dunno if you're being sarcastic or not but Ill tell you guys what I do and hope I don't get laughed at....

I like to write calls on blue chips due to more people wanting to buy them.

I use commsec and they will charge around $35 per option transfer.

I like to use atleast 2 option contracts per transfer so I only get charged that $35 brokerage once.

I normally wait until the 2nd week in the month and start looking for a black day to get the best premium for the call on the market. 2nd week because you only have to wait around 10 trading days until the option contract expires. Normally the price of the premium will not move down much in the first 2 weeks.

If I have 2 ANZ options contracts to sell and ANZ is currently at $24 with 10 trading days to go I'll aim for around the $24.50 or $25 strike price. 25 is safer but you'll receive a smaller premium than the 24.5 strike price.

You don't have to pay anyone and the person who buys the contract off you pays you the premium at T+1.

Nearly all brokers will offer options.
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No another note, if you like to hold stock for the yield why the heck wouldn't you write calls??? even if you write calls and only receive $100 a month for a call that would realistically never be "EXERCISED".

Im only really a newbie at this but I've made a few grand off options so far and completely no downside. so far...

 

[nunthewiser]

No not being sarcastic.

i have never taken the time to look into them

cheers

 

[cutz]

No not being sarcastic.

i have never taken the time to look into them

cheers

Check them out nun,

Options are way cool.

 

[nunthewiser]

Check them out nun,

Options are way cool.

As long as it dont interfere with my my fornicating and drinking time i may well have to

 

[wayneL]

I dunno if you're being sarcastic or not but Ill tell you guys what I do and hope I don't get laughed at....

I like to write calls on blue chips due to more people wanting to buy them.

I use commsec and they will charge around $35 per option transfer.

I like to use atleast 2 option contracts per transfer so I only get charged that $35 brokerage once.

I normally wait until the 2nd week in the month and start looking for a black day to get the best premium for the call on the market. 2nd week because you only have to wait around 10 trading days until the option contract expires. Normally the price of the premium will not move down much in the first 2 weeks.

If I have 2 ANZ options contracts to sell and ANZ is currently at $24 with 10 trading days to go I'll aim for around the $24.50 or $25 strike price. 25 is safer but you'll receive a smaller premium than the 24.5 strike price.

You don't have to pay anyone and the person who buys the contract off you pays you the premium at T+1.

Nearly all brokers will offer options.
-------
No another note, if you like to hold stock for the yield why the heck wouldn't you write calls??? even if you write calls and only receive $100 a month for a call that would realistically never be "EXERCISED".

Im only really a newbie at this but I've made a few grand off options so far and completely no downside. so far...

That's all fine (though I think the approach could be improved). If you are holding the shares anyway, and you don't think the sp is going to blast through your strike, it's a good strategy.

One point though - TAX.

It is probably better that you dodge assignment to dodge possible CGT if applicable. There is no reason to sit there like a stunned mullet with an ITM covered call. You can simply trade out of it before expiry.

Yes you might be losing money on the call, but the net result is the same, without precipitating a CGT event.

 

[BrightGreenGlow]

That's all fine (though I think the approach could be improved). If you are holding the shares anyway, and you don't think the sp is going to blast through your strike, it's a good strategy.

One point though - TAX.

It is probably better that you dodge assignment to dodge possible CGT if applicable. There is no reason to sit there like a stunned mullet with an ITM covered call. You can simply trade out of it before expiry.

Yes you might be losing money on the call, but the net result is the same, without precipitating a CGT event.

Yes this is true. If im a few months away from holding the shares for a year I'd be pretty hesitant to write a call due to CGT. But like you said if you're holding the stock its a good little money maker.

 

[village idiot]

The decision for the trader is - is the premium collected worth the risk profile assumed?

this is the guts of the whole thing, and wayne also correctly states somewhere else that the premium has to be compared to the probability of various outcomes, or in other words the anticipated distribution of share price returns over the time till expiry, to determine whether writing this call at this time for this premium has a positive expected value, or a higher expected value than whatever the alternative is (presumably continue to hold the stock).

here is a chart of a very crude method of comparing the cc strategy to a buy and hold strategy; the share is NAB and the period is feb 2003 to may 2010

the thick blue line represents the difference in returns ie the improvement or other wise between always being short a call over 100% of the stock v a simple buy and hold stategy

the calls measured are all 20 trading day duration and in this chart i have assumed a constant 3% premium is obtained, which is equivalent to an IV of 26%

all good eh in this case since buy and hold has produced a negative return, writing calls has improved the return considerably.

now this is the same chart but i have changed the premium recieved each time to 2% which equates to an IV=16.5%;

different story now we are only getting 2%, which appears to be around the equilibrium point where the two strategies are roughly equal


now I of course know that the premium is never a constant and indeed it fluctuates a lot (i did say it was a crude analysis) but the point is that IT DEPENDS HOW MUCH YOU GET for assuming that obligation.

That is to say, you should not just decide that writing calls is a great strategy and just blindly write call after call without considering the level of premiums available v the distribution of possible outcomes. Or in other words comparing IV to expected volatility. Or to shorten it some more; sell premium when IV is higher than expected volatility.


now here is another one with completely diffrent price behaviour. This time the stock is BHP which has roughly quadrupled in price over the same time. in BHP writing calls at 26% IV would have resulted in severely curtailing the capital growth that buy and hold enjoyed.

now i change the premiums recd to an unlikely 5% and this chart shows that IF YOU GET ENOUGH premium writing calls can have a + EV even on a rising stock.

Personally i am a fan of writing calls on blue chip stocks that i hold and am happy to hold for the long term, but always subject to the IV available and the stocks position its own range. It doesnt get mentioned often but another variable you can influence is you can vary the ratio between stocks held and options written. depending on circumstances i may write calls on between 50% and 200% of stock held, which has a big influence on the payoff profiles

I am also a fan of writing puts as an accumulation and trading strategy, if circumstances are appropriate, and if i can get them on the same stock as we are short a call on at different points in its trading range so much the better.

One thing i wouldnt ever do is buy stock and write a call at the same time ie buy/write. If i wanted to assume that payoff profile i would instead write a naked put - same payoff, less capital tied up.

also agree with wayne that stocks with a high IV generally have a good chance of a big move either way, and these are the least appropriate for doing a buy/write on due to the unfavourable risk:reward ratio (ie small win or big loss). For me, i stick to blue chips for this stategy

 

[wayneL]

Here is an interesting comparison:

The CBOE has an SP500 buy/write index which I've plotted with the SP500.

I has outperformed a bit since "the troubles" because of the general overpricing of volatility since then, but previous to that, not a lot of difference.

 

[mazzatelli]

also agree with wayne that stocks with a high IV generally have a good chance of a big move either way, and these are the least appropriate for doing a buy/write on due to the unfavourable risk:reward ratio (ie small win or big loss).

If you put a gun to my head, I'd rather sell vol in a more volatile stock than a quiet one.

Funnily enough, relating to Wayne's comment about overpricing of vol.
Paradox, perhaps?

 

[ENP]

Wow, those graphs and charts are fantastic at explaining exactly what I was looking for!!

Thanks everyone.

 

[wayneL]

He says he earns 5% return per month. This basically equates to about a 70% return every year. He says he spends 15 mintues per month actively doing it.

I mean 70% return with "no risk" is this guy for real? If it's this easy why doesn't everyone do it?

Look forward to your honest opinions on the subject.

Thanks.

Note that the charts scupper the x% per month fallacy.

CCs written on sp500 would be in overall loss over the last two years and up only 10% over 5 years.

 

[ENP]

Note that the charts scupper the x% per month fallacy.

CCs written on sp500 would be in overall loss over the last two years and up only 10% over 5 years.

I just forwarded the link to his email and he replied with...

"that'd be depressing if you were writing covered calls that badly!!! don't know of anyone that writes them on the S&P... perhaps for good reason - small yield?"

 

[wayneL]

I just forwarded the link to his email and he replied with...

"that'd be depressing if you were writing covered calls that badly!!! don't know of anyone that writes them on the S&P... perhaps for good reason - small yield?"

As with most beginners sold a story, your friend misses the point. Unfortunately, he will have to learn the hard way.

 

[village idiot]

that is indeed an interesting chart wayne, I didnt know that index existed but now i know something i didnt before and that is never a bad thing.....

my read from that chart would be that basically all the out performance was in the bear market from 2008 thru early 2009, which is as you would expect since one of the undoubted characteristics of call writing is it does provide a smallish cushion against a drop in sp, and is supposed to outperform buy and hold any time the sp falls.

the rest of the time was essentially in uptrends when the strategies are evenly matched, again as you would expect if the slope of the uptrend matches the level of premiums....

 

[village idiot]

mazzatelli, am i reading your reply right in meaning that you would need a gun held to your head to sell premium at all?

if so, what strategies are you into if you dont mind me asking...

 

[ENP]

As with most beginners sold a story, your friend misses the point. Unfortunately, he will have to learn the hard way.

You seem to be pretty onto in Wayne, what is your past experience? Basically what are your credentials and why should I take your opinion?

(not trying to down talk you, just wanting to know a bit about your experience with these types of investments)

Thanks,

 

[wayneL]

You seem to be pretty onto in Wayne, what is your past experience? Basically what are your credentials and why should I take your opinion?

(not trying to down talk you, just wanting to know a bit about your experience with these types of investments)

Thanks,

I have no credentials but trade an option or two.

You shouldn't take my opinion as gospel, but analyse what I say for integrity, accuracy and logic, then make up your own mind.