articles on covered call options
 

Hey guys, I need help finding good articles on covered call options that have been published within the last year. Thanks in advance.

Re: articles on covered call options
 

more specifically, the relationship between calls and writing them.

Re: articles on covered call options
 

Not sure what you are trying to learn, but just in case, do you understand that if you are a long term investor selling covered calls you are selling your upside?

Re: articles on covered call options
 

I've heard of a study saying that covered call writers perform better than ordinary stockholders over the long run. I've sorta seen this from my own experience with covered call writing - it's not rare that I get a >1% monthly return while only selling my upside above a 20 or 30% return on the stock. Think about that - writing seems pretty lucrative. If anyone knows of any such article/research, please throw it my way. I suck at searching and haven't been able to find anything.

Re: articles on covered call options
 

If it were true that cc writers were more profitable, it means that calls in general are overpriced. I see no evidence of this. You have been lucky so far but you have a small sample size. Someone else is likely complaining that their favorite long term hold just spiked thirty percent and got called out from them, costing many times more than the premiums earned.

Re: articles on covered call options
 

well, here's what I'm saying - the stocks I'm writing covered calls for can rise 30% and still won't reach the strike price - and I'm being paid about 1 or 2% a month. If I wrote within 10% of the strike price I could get 5 or 6%. I have no hard data to support it for you, but I wouldn't be surprised at all if calls were overpriced for some stocks.

Re: articles on covered call options
 

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I've heard of a study saying that covered call writers perform better than ordinary stockholders over the long run. I've sorta seen this from my own experience with covered call writing - it's not rare that I get a >1% monthly return while only selling my upside above a 20 or 30% return on the stock. Think about that - writing seems pretty lucrative. If anyone knows of any such article/research, please throw it my way. I suck at searching and haven't been able to find anything.

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Depends on the mkt environment and if you are hedging the stock and options 1:1

If 1:1, then why not just sell deep puts outright? (I guess it makes sense if there are capital recs for retail customers)

Re: articles on covered call options
 

A covered call is equivalent to shorting a put but probably will have higher transaction costs and tie up more capital. Shorting the put is thus probably a better way to go but not a good way to go IMO.

Re: articles on covered call options
 

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well, here's what I'm saying - the stocks I'm writing covered calls for can rise 30% and still won't reach the strike price - and I'm being paid about 1 or 2% a month. If I wrote within 10% of the strike price I could get 5 or 6%. I have no hard data to support it for you, but I wouldn't be surprised at all if calls were overpriced for some stocks.

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Can you name the stocks you write against? It sounds like you have some very volatile holdings, once again I doubt there is a free lunch. You are getting big premiums because the risk of getting called out is relatively high.

For example, KO is $54. The October $57.50 calls last traded for twenty cents. That works out only to about 0.37% premium (not counting transaction costs) for almost 6 weeks exposure to only a 6.5% move. Of course KO is a low volatility stock that rarely moves, but every so often some news will drive it up much more than 6% in a short period.

Some expensive premiums are for stocks with binary futures, for example a drug company that has a blockbuster drug in testing and the test results will either make the company worth zero or 2x current price. If you owned a company like that covered calls wouldn't make much sense because you'd be giving away most of your upside while retaining all of the huge downside risks.

I do believe that some options are mispriced and smart options traders can be significantly +EV if they know how to find specific opportunities. But if you are just writing calls because you own the stock, odds are the price fairly reflects the best estimates of future volatility.

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I agree with what you're saying, mostly. In fact, I almost totally agree. I'm just going out on a limb though and conjecturing... can anyone show me any data that options pricing as it exists in the market or the options pricing models aren't biased one way or the other?

Just for reference, what dictates option pricing? It's my understanding that a market maker sets prices according to an options pricing model like Black-Scholes and then that price is influenced by supply and demand. I could be way off though, I don't know the inner workings of the options markets.

So, what is to say that the black-scholes model, while applicable to the stock market as a whole, might not over or under-price options for a specific equity/industry? Or maybe the supply and demand that dictates which way option prices go is skewed one way or the other - either creating returns that are higher than justified or lower than justified - sorta like when the stock market has had periods of relatively low P/E's in the past. Relative option prices wouldn't be affected, but the overall premiums might be off.

Anyhow, just some random thoughts. I'm very new to all of this stuff and mainly spewing my own thoughts. Can anyone recommend any good options books that are in depth, yet practical for the day to day trading of options, or finding opportunities?

Re: articles on covered call options
 

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For example, KO is $54. The October $57.50 calls last traded for twenty cents

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KO is a bad example because it is a very low volatility stock. I own Coke and have never written options against it and never will for this very reason and I am a serial covered option writer.

It all comes down to what you are trying to accomplish. Take something a bit more volatile for example. AAPL closed at 136.76 today and the Sept 140 calls closed at 4.16. If that gets called away in a couple of weeks you just made 5% in less than a month. If it doesn't you bought the stock 4 bucks cheaper than otherwise and you can sell some more against it next month.

Covered call writing is more of a trader than investor mindset. To each is own. Both strategies can work well if you know what you are doing and what you are trying to accomplish.

Re: articles on covered call options
 

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Just for reference, what dictates option pricing? It's my understanding that a market maker sets prices according to an options pricing model like Black-Scholes and then that price is influenced by supply and demand. I could be way off though, I don't know the inner workings of the options markets.

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This is a pretty good summary for the purposes of this discussion.

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So, what is to say that the black-scholes model, while applicable to the stock market as a whole, might not over or under-price options for a specific equity/industry?



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Not all inputs into pricing models are fixed (i.e. future estimates of future underlying volitility, interest rates, ect). Options pricing is determined by the "supply and demand" of varying takes on these variables.

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Or maybe the supply and demand that dictates which way option prices go is skewed one way or the other - either creating returns that are higher than justified or lower than justified - sorta like when the stock market has had periods of relatively low P/E's in the past. Relative option prices wouldn't be affected, but the overall premiums might be off.


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This absolutely happens, but rarely in very liquid stocks.


Basically, if you are writing a covered call you want stock to go up, but not through your short strike before expiration. If it does, then you would have been better off just owning the stock

Re: articles on covered call options
 

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It all comes down to what you are trying to accomplish. Take something a bit more volatile for example. AAPL closed at 136.76 today and the Sept 140 calls closed at 4.16. If that gets called away in a couple of weeks you just made 5% in less than a month. If it doesn't you bought the stock 4 bucks cheaper than otherwise and you can sell some more against it next month.

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Skindog is selling covered calls that are 30% out of the money for 1-2% per month. AAPL OCT $175 (about 30% out of the money) sell for $1.15, about 0.5% per month. Can you imagine how volatile the stocks he's writing against are? Or is Skindog doing a bit of exaggerationing?

Earning 5% in a month is great, but not at the expense of being called out of your stock when it shoots way higher. In August AAPL bounced between $111 and $139. Imagine the second week of August when your Apple stock was $120 you sold some covered calls at $125 for $4. Apple closed at $127 the last day of options. The next day it was trading for $130 and a week later $139. But you got called out of your shares for $124.

There is no free lunch with options. The chance that your stock will trade higher than the call price is worth something, about what you sell it for. Worse is that if you want to hold the stock long term every time it gets called your long term capital gains clock gets reset, making it more likely you'll pay higher tax rates. Plus you have to pay transaction costs in an expensive, illiquid options market that only trades in nickels.

Re: articles on covered call options
 

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Skindog is selling covered calls that are 30% out of the money for 1-2% per month. AAPL OCT $175 (about 30% out of the money) sell for $1.15, about 0.5% per month. Can you imagine how volatile the stocks he's writing against are? Or is Skindog doing a bit of exaggerationing?

Earning 5% in a month is great, but not at the expense of being called out of your stock when it shoots way higher. In August AAPL bounced between $111 and $139. Imagine the second week of August when your Apple stock was $120 you sold some covered calls at $125 for $4. Apple closed at $127 the last day of options. The next day it was trading for $130 and a week later $139. But you got called out of your shares for $124.

There is no free lunch with options. The chance that your stock will trade higher than the call price is worth something, about what you sell it for. Worse is that if you want to hold the stock long term every time it gets called your long term capital gains clock gets reset, making it more likely you'll pay higher tax rates. Plus you have to pay transaction costs in an expensive, illiquid options market that only trades in nickels.

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Very well said.

Re: articles on covered call options
 

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It all comes down to what you are trying to accomplish. Take something a bit more volatile for example. AAPL closed at 136.76 today and the Sept 140 calls closed at 4.16. If that gets called away in a couple of weeks you just made 5% in less than a month. If it doesn't you bought the stock 4 bucks cheaper than otherwise and you can sell some more against it next month.

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Skindog is selling covered calls that are 30% out of the money for 1-2% per month. AAPL OCT $175 (about 30% out of the money) sell for $1.15, about 0.5% per month. Can you imagine how volatile the stocks he's writing against are? Or is Skindog doing a bit of exaggerationing?

Earning 5% in a month is great, but not at the expense of being called out of your stock when it shoots way higher. In August AAPL bounced between $111 and $139. Imagine the second week of August when your Apple stock was $120 you sold some covered calls at $125 for $4. Apple closed at $127 the last day of options. The next day it was trading for $130 and a week later $139. But you got called out of your shares for $124.

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How often does that happen, on average? Not very often, considering the average gain of the market is about 10% a year. In the AAPL example, he's beaten that in 3 months.

Re: articles on covered call options
 

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The chance that your stock will trade higher than the call price is worth something

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Duh! It's all about risk, reward, and expectation. If you aren't comfortable selling calls then don't. If you are comfortable with it and understand the risks (and rewards) you can enhance your profitability.

Like I said it's more trading than investing and some people think all trading is evil. I'm a trader and not an investor so when I see a good covered opportunity I take it. When writing calls my hope is generally that I DO get called away. The real risk is the stock tanking and getting stuck with it.

Re: articles on covered call options
 

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Imagine the second week of August when your Apple stock was $120 you sold some covered calls at $125 for $4. Apple closed at $127 the last day of options.

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Hmmm? That figures out to a $9 gain in 2 weeks or about 7.5%. That's an annual return of about 180%. Nice trade!

Re: articles on covered call options
 

DesertCat,

You make it sound like there is no place for covered calls, that a stock is either good or bad. If bad then don't buy the stock, if good then don't sell the covered call.

Ignoring taxes, what if you buy a company only because you think it is underpriced? You don't buy it because you think the business has any outstanding potential, but merely because you look at the company's assets and you think the stock price is low compared to that. You buy it only because it shouldn't go down. Then both your short at the strike price as well as your long-term holding is justified.

(I rarely write calls because most of my picks don't fall into this category. I also agree with your underlying premise that if you are selling a call you are selling a call, and the value of that call is separate from your stock purchase)

Re: articles on covered call options
 

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Imagine the second week of August when your Apple stock was $120 you sold some covered calls at $125 for $4. Apple closed at $127 the last day of options.

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Hmmm? That figures out to a $9 gain in 2 weeks or about 7.5%. That's an annual return of about 180%. Nice trade!

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Someone owning the stock made double the gain and can still qualify for long term cap gains. Any long term holder who bought Apple at $10 and rode it all the way up to $140 would likely have cost themselves lots of profits by selling covered calls.

There is nothing wrong with being a trader, but it just seems naked options would be a better vehicle for trading than covered calls. For the long term investor you are losing upside a while lowering variance. If you need that, a better approach would be to add some bonds while keeping your equity holdings tax efficient.

Re: articles on covered call options
 

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but it just seems naked options would be a better vehicle

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Good luck with that [img]/images/graemlins/smile.gif[/img]

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For the long term investor you are losing upside a while lowering variance

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Not neccessarily, there are plenty of uses and strategies for longer terms but you are closed minded enough that I'm willing to drop this conversation completely.

Re: articles on covered call options
 

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DesertCat,

You make it sound like there is no place for covered calls, that a stock is either good or bad. If bad then don't buy the stock, if good then don't sell the covered call.

Ignoring taxes, what if you buy a company only because you think it is underpriced? You don't buy it because you think the business has any outstanding potential, but merely because you look at the company's assets and you think the stock price is low compared to that. You buy it only because it shouldn't go down. Then both your short at the strike price as well as your long-term holding is justified.

(I rarely write calls because most of my picks don't fall into this category. I also agree with your underlying premise that if you are selling a call you are selling a call, and the value of that call is separate from your stock purchase)

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I don't agree with Desert Cat about how he reads the "tea leaves" all the time but he's a smart guy. He's totally right IMO regarding the value in writing covered calls i.e. it's a poor idea. If you must do it I'd recommend shorting puts instead. Same risk profile, same EV, less transaction costs, and less capital tied up. Really though, I'd strongly recommend not doing it FWIW.

Re: articles on covered call options
 

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For the long term investor you are losing upside a while lowering variance

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Not neccessarily, there are plenty of uses and strategies for longer terms but you are closed minded enough that I'm willing to drop this conversation completely.

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If you have something to add to the conversation, by all means go ahead. I'm not close minded so you don't have to take your (base)ball and just go home. Our conversation has been so far

Me: covered calls didn't work out so well in August for APPL holders.

You: They made $9!

Me: Buy and holders would have made more.

You: OMG how dare you point that out. I know so much more than you but instead of educating everyone I'm just going to stamp my feet and go away!

Sounds silly doesn't it? So lets start over, what have I missed? How do covered calls generate excess after tax returns over just buying and holding the stock for long term investors?

Re: articles on covered call options
 

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do covered calls generate excess after tax returns over just buying and holding the stock for long term investors?

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I'm gonna get back in on this

I don't think bringing up specific examples does anything to bring the discussion one way or another. I can find a mountainload of cases where writing a covered call resulted in more profit than either buying the stock by itself or writing a call by itself.

Personally, I do it for stocks that I am bullish on (I wouldn't want to hold stocks just for covered call writing) if I feel both that the option provides a good reward and that the stock's raw 'volatility' isn't a good representation of whether the stock will reach a certain level. It is definitely more of a trading thing than an investment thing.

Just because I'm bullish on the stocks I buy, I might be hesitant to write something like the AAPL 125 call. Yes, you get a lot of cash for your time value, but like you pointed out - it's for a reason. In my covered call writing I leave enough room such that if the stock spikes and does hit the strike price, I will be very happy with my stock returns for the month. In all cases, I use it as something of a bonus return for my investment rather than an end-all strategy.

Like I said, I have a feeling that properly used, under specific circumstances that certain stocks face, covered call writing might bring abnormal returns. I don't write covered calls for every stock I own.

I can tell you definitively that I've made more money using covered calls than if I had not used them.. but that obviously doesn't prove anything with my short investing timeframe.

I think the most useful way of proving any point would be for either side to bring some articles or sources to the table.

Re: articles on covered call options
 

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Me: Buy and holders would have made more

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No. Option seller could have bought it back at 127 and been $2 ahead of the buy and holders.

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Me: Buy and holders would have made more

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No. Option seller could have bought it back at 127 and been $2 ahead of the buy and holders.

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If covered calls are so lucrative, why not sell the calls naked? All of the profits without tying up as much capital. If the stock closes over the call price you just buy at market and take a small loss. A small loss because stocks that pay big premiums never go up much, right?

Re: articles on covered call options
 

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If covered calls are so lucrative, why not sell the calls naked?

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Some do but as we all know it can be risky. But if I own a stock and have a target where I would like to sell it then why not write the call and (possibly) get some extra return? And if I see an opportunity for something I like (to own) with limited downside (in my mind) and I can buy it and write the call knowing that if I get excersized I made a reasoanble return and in fact my goal why not write the call? And if I can sell calls far enough out where I would be very happy to be called away then why not write the call? And if I want to sell a stock why not write a deep instead and get more return?

All depends on your goal and expectaion.

Re: articles on covered call options
 

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Some do but as we all know it can be risky. But if I own a stock and have a target where I would like to sell it then why not write the call and (possibly) get some extra return? And if I see an opportunity for something I like (to own) with limited downside (in my mind) and I can buy it and write the call knowing that if I get excersized I made a reasoanble return and in fact my goal why not write the call? And if I can sell calls far enough out where I would be very happy to be called away then why not write the call? And if I want to sell a stock why not write a deep instead and get more return?

All depends on your goal and expectaion.

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Although I completely agree with mrbaseball and everything he has written in this thread, all but one of the stocks I was writing calls against in the past few years blew through the OTM strike price making substantially less money than the buy and hold strategy would have. The money left on the table does cause some mental pain even though the returns are still substantial.

Re: articles on covered call options
 

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But if I own a stock and have a target where I would like to sell it then why not write the call and (possibly) get some extra return?

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Suppose that you own a stock that trades at $X but you do not want to sell it lower than $Y.

If $X>=$Y, then sell it.

If $X<$Y, you view the stock is undervalued. Correspondingly, a call on the stock will be undervalued as well and you should not sell the call. The price of the call is dictated by the price of the stock, so if the market is undervaluing the stock, it will also be undervaluing the call (unless you have some very specific beliefs about the return distribution).

And I'll anticipate a response: It doesn't matter that you're selling a call with a strike price of $Z, which is greater than $Y - that call will still be underpriced and you should not be selling it if you believe the underlying stock is underpriced.

Re: articles on covered call options
 

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The price of the call is dictated by the price of the stock

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And many other factors. The VIX (volatility index) was up approximately 2.5 points today. This has a tremendous effect on the price of options regardless of the price of the stock. I don't like selling options in a low volatiltiy environment but right now if there is a stock you like the options are likely higher priced today than they were yesterday meaning a covered call or naked short put could be appealing if you are looking to get long.

Re: articles on covered call options
 

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And I'll anticipate a response: It doesn't matter that you're selling a call with a strike price of $Z, which is greater than $Y - that call will still be underpriced and you should not be selling it if you believe the underlying stock is underpriced.


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I'll stipulate that this is true the instant you sell the call. But every moment that passes the option becomes less undervalued. Unless you anticipated a rapid upward movement in the stock this is not a good reason not to sell covered calls. If you had anticipated such a rapid rise you wouldn't be selling a covered call in the first place so I must disagree with your post.

Jimbo

Re: articles on covered call options
 

just a quick interjection about studies involving returns/risks of strategies that involve selling of options.

unlike typical securities, the risks associated with option writing are not always visible in the data. even long term studies may miss a good deal of data and thus bias the riskiness of the strategy or whatever is being studied.

i remember reading somewhere that on average, options tend to be slightly overpriced...possibly due to relatively larger demand to hedge long/short positions than to sell to those who wish to hedge. one thing the study/article noted though was that it would make perfect sense for the average option price to be that much higher if you account for unobserved risks of selling of options. i.e. sellers require higher rates to write options.

in "house of money" a few of the managers who drubny interviewed mentioned they didn't like being short volatility.

clearly though there are places for selling options in setting specific strategies as mrbaseball has shown a bit.

just be aware that selling naked options may seem more attractive than it is due to lack of realized and observed risks.

there is a lot on this topic, but those are just a few thoughts.

Barron