articles on covered call options

[mrbaseball]

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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.

[RarocASP]

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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

[DesertCat]

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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.

[RicoTubbs]

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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.

[pig4bill]

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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.

[/ QUOTE ]

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.

[mrbaseball]

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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.

[mrbaseball]

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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!

[disjunction]

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)

[DesertCat]

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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.

[mrbaseball]

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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.