Request for Feedback on Covered Call Strategy

Posted by architortured on April 24, 2008 (09:35AM)

I own 100 shares of INTC that I would like to use to write covered calls as an introduction to option trading.

Here is the strategy that I am considering. I would like some feedback on it.

  • Write an OTM call option that is 30 - 45 days from expiration.
  • Write a call option whose premium is at least 2% of the stock price. (INTC is currently $22.69, so at least $0.45)
  • Write a call option whose implied volatility is around 30%
  • After writing the covered call option, place a contingent order that says if the stock price reaches the strike price, buy back the option.
  • Wait and hope that the option expires worthless.
  • Repeat the process once the option expires or once the contingent order kicks in.
  • Steps 1 and 2 are straight out of the options playbook. Am i interpreting these correctly?

    Step 3 is from the OptionGuy's Blog 

    Steps 4 through 6 are my own intuition.

    According to the rules set in steps 1 - 3, I am looking at writing a June 08 call option with a strike price of 24.



    Posted by architortured on April 24, 2008 (10:57AM)

    I should also mention that I am bullish on INTC with a target price of 26 or so. This is why I want to place contingent orders to prevent myself from being assigned.

    I am trying to use the Covered Calls to generate additional cash.

    Posted by RogerLee on April 24, 2008 (01:50PM)

    Your on the right track.  A tip is to only sell calls on a day when your stock is up.  Call prices get slightly exaggerated (in your favor) when a stock runs higher.  Also, I would not use a contingent order to buy the call back automatically.  Intel may fluctuate up 3 or down 3 dollars a couple of times during your 30-45 day period.  The chances of being assigned before expiration day is virtually nill. It's best to hold on until expiration day then buy it back.  That way all the time premium is gone.

    Good Luck 


    Posted by optionsguy on April 25, 2008 (05:34AM)

    Hello Architortured,

    First of all, let me say that it is great to see you have a plan and not just selling a call to say you sold a call. The 2% of the stock price and the 30% implied volatility kind of go hand in hand. You need to have a "decent" implied volatility premium to be able to get the 2% especially if you are using a 30 to 45 day option. On step 4 (contingent order), I would not automatically buy back the option and roll it. I would look at the trade and if I was still bullish on the stock I would roll the call in the spread order screen all as one trade. Example: buy to close and sell to open for a net credit to the account. When trading options it is very important to work the trade and try to get the best fill possible. Just buying back the option at market because the stock hit the strike will mean you are always buying to close at the ask, buy working the trade as a spread usually means you can achieve better overall prices on each option. You will need to have a down stop on the stock also, don't let the stock drop too much before getting out of the entire position and finding a better stock (FYI... there is a chapter on rolling at the end of the playbook).

    Brian (Og)

    Posted by architortured on May 03, 2008 (10:17AM)

    Thanks for your suggestions RogerLee and Brian.

    I have modified my strategy based on your recommendations.

  • Write an OTM call option 30 - 45 days before expiration on a day the underlying is up 3% in one day, 4% in two days, or 5% in three days.
  • Write a call option whose premium is between 2% and 2.5% of the stock price. (INTC is currently $23.58 so between $0.47 and $0.59)
  • If the call option is ITM on expiration day, use the spread order screen to buy back the call option and sell a new option to cover the cost of the buy back (up to 3% of the current stock price)
  • If the call option is OTM on expiration day, allow it to expire worthless and repeat the process.
  • Any additional feedback? Do I need to have a stop loss on the call option in case the stock shoots through the roof?

    Two days ago INTC gained 4% in one day and I sold a June 24 Call option 51 days before expiration for $0.50. I am feeling a little regret for breaking my rule #1, but I felt the need to take advantage of a Intel's jump in price. See my trade notes for more on this.

    I'll keep y'all updated with how this play goes. Yesterday the June 24 Call option's last trade was $0.68.

    Posted by Potaire on May 03, 2008 (03:54PM)

    I am probably almost as excited as you are about your move.  This is the exact thing I want to do--as you probably know from my monster-thread concerning covered call questions.  Do you have just the 1 call going, or did you sell several of the same call?  I will be most interested to see how you did when the dust is all settled.

    Best of luck to your plan,


    Posted by architortured on May 14, 2008 (06:32AM)

    Just a quick update:

    INTC has been rising steadily for the past week, or so. Today, INTC rose above the stike price of the June 24 Call option that I wrote a week or so ago. My first reaction to seeing this was to roll my position up to a June 25 Call. When I looked into it further I could roll this option for a $0.47 debit (Buy to Close June 24 Call for $0.87; Sell to Open June 25 Call for $0.40)

    Perhaps this would be a good move, but I do not fully understand the implications of it. I sold my original June 24 Call option for $0.50. Any thoughts from the community on whether or not rolling my position now would be a good idea?

    For now, I am going to stick it out and see what happens. The rules I set for myself on this play say I am going to wait it out until expiration (see my previous post). And as RogeLee says, "Intel may fluctuate up 3 or down 3 dollars a couple of times during your 30-45 day period."

    (just the 1 call going, Potaire) 

    Posted by BobJohnson on May 14, 2008 (07:54AM)


    I like your game plan on Intel. Here are my comments:

    1. 30-45 days is perfect. I read in an aritcle, where someone did some statistical work and found that the implied volatility is higher than the actual volatility during this time period, so call options are overpriced. This is good for the seller. For over 60 days, the implied and actual volatility numbers are much closer.

    2. Covered calls that are

    3. I totally agree with optionsguy on spread order. You definitely get tighter bid/ask spreads. If you do a market order 'buy to close', you will get gouged. 

    4. Based on that article I read, if the call goes ITM, it's better to let the shares get called away, and just open a new position. The rolling costs is more expensive than the opportunity loss over the long run. However the author was considering typical brokerage fees... but Tradeking commissions are much lower, so rolling could be better in this case.  Personally, I would let it get called away.

    5. You mentioned about breaking your own rule. I find that interesting, because everytime I get into a new position, I expect a 5-10% return in 30-45 days. Sometimes on an eventful day, I would panic and close it out and end up at breakeven or maybe a 1% loss. The funny thing is, if I followed my own rule and hung tight, I would've got what I expected.  

    6. If you like covered calls, and you're bullish on INTC, you might want to consider diagonal spreads. It's like covered calls on steroids. Here, you buy Deep ITM LEAPS, and sell short-term calls against it. However if the stock moves significantly lower... you're toast.

    Posted by architortured on June 22, 2008 (06:22PM)

    My INTC June 24 call option expired worthless. RogerLee's advice (see above) proved to be good advice this month as INTC rose as high as $25 in the middle of May (see my post from May 14 above), but then fell back below my option contract's $24 strike price.

    Because of how the option calendar works this month, I would have to break my rule #1 to open a covered call position for July. The June contract expired with less than 30 days till July's expiration. My option trading level is such that I can only sell July options once the June option expired or was bought back.

    I would allow an exception to this rule and start shopping for a INTC July option today; however, I will sit this month out since I will be traveling without internet access for all of July.

    Take care, happy investing.

    Posted by runningpair on June 24, 2008 (07:33AM)

    Just an observation about Roger's suggestion to wait until stock rises to sell a call.  Two things here. 

    1.   You are losing time value while waitnig for an increase in implied volitility, so it may happen that the time value lost exceeds the gain from implied volitility.

    2.  Who says the stock will go up?  If we knew this we wouldn't sell calls or even buy the stock.  We would just load up on the option.  It is going up right?



    Posted by runningpair on June 24, 2008 (08:02AM)

    One other thing while you are holding the stock waiting for it to move up you will have a delta of 1, obviously you have the full risk of owning the stock.  You will reduce this risk to about .6  when you sell the near the money call.  This has the effect of reducing your risk of ownership to about 60 shares.

    Posted by architortured on June 25, 2008 (04:34PM)

    runningpair, I have observed that INTC's price fluctuations from day to day have a much larger affect on the bid and ask values for the option contracts than the impact of time decay from day to day when the option contract is still 30 - 45 days from expiration.

    Realizing that stocks tend to jump a few percentage points from day to day while usually returning to an average trend, I am trying to sell my covered calls on a day that the stock is up. You do make a good point. Perhaps I should check my somewhat arbitrary percentages (3% in one day, 4% in two days, or 5% in three days) against historic data to make sure that I will eventually open a position in most months. Perhaps my criteria is too stingy now.

    You make a very good point in your most recent post that I have not considered. I will think this over and adjust my plan accordingly when I get back in "the game" after my travels.

    Posted by OldFart on June 27, 2008 (08:09PM)

    Hi All! Interesting discussion on covered calls. I am new here and still learning the ropes, just wanted to mention that Covered Calls (long shares + short calls) = Naked (short) Puts. It really depends what you are trying to achieve however from risk perspective they are the same and the naked puts are one transaction (one fee) where the covered calls involve two comissions - purchase the shares and sell the calls. And because of the "smile" the puts usually carry higher premium (higher IV) than the calls


    Posted by architortured on June 27, 2008 (09:35PM)

    I have looked at naked short puts, and I like them better than covered calls. Unfortunety my options trading level does not let me short naked puts. Someday.

    What is this "smile" that you speak of?

    Posted by OldFart on June 28, 2008 (05:15PM)

    Hello Architortured,

     I understand your point. Being new here, it is beyond me why TK requires Level 4 and $25K account to sell naked puts. There was an earlier discussion here that it is clearing firm requirement. it is their decision and we need to follow the rules. Be as it may be I am a BIG CHICKEN and covered calls and naked puts are too scary for me. Usually if I think a stock will go up, I would sell a put vertical - short higher OTM put and long lower put. Sure, the credit is less but the risk and margin required are much less (no Level IV) and the return on margin is very respectable. Some times the lower put can be even in a further away month

    Regarding the "smile" - in general OTM puts trade with higher IV than the OTM calls after the 1987 market crash. If one draws a graph of implied volatility (vertical) at different strike prices (horizontal) the graph looks like a smile or maybe a smirk (they say).  It is a long discussion why the smile (why the options trade with different IV) is present but to a degree it makes sense. The market is more afraid of crashing down vs crashing up (if there is such a thing) and bids up put prices

    Posted by OptionA on June 30, 2008 (03:35PM)

    I'm no expert on covered calls, so maybe someone else can verify this, but I think you might want to pay attention to the historical volitility as well.  A 30% implied volitility doesn't mean much, if historically the stock is extremely volitile.  I would think that you would also want a stock who's implied volitility is greater than the historical volitility, and maybe you even want to put a number like at least 10% greater than HV.

    If you have a strong inclination that the stock will go up to the target, eventually you might want to learn to just do a bull call spread.  If your target was $26, you could buy maybe buy an ATM call, and sell one at $26.  This is better than writing a call against the stock since you expect it to go up a significant amount, but is better than just buying a call, because you don't expect the stock to go nuts and rise much past $26.  A bull call spread lowers your break even on just buying a call in exchange for capping your upside, however you will most likely collect the premium, and if it does go up past the strike price of the $26 call write you have at least locked in the max gain.

    Bull call spreads are great for those who set targets and plan to sell AT the target, or perhaps before.  It's a great "bullish up to a certain point" strategy. You need to have a level 3 option account to do this.

    Posted by OptionA on June 30, 2008 (04:06PM)

    "OldFart", TK is following federal regulations.  The requirements for each level are federally mandated, so it's not just TK. I personally think the rules are kind of strange.  I think it's more appropriate for some people to have level 3 than level 1. I applied as a level 2 and got it, but now that I've read some more books, and have really developed a style I am confortable with, I realize that I usually sell at or before a target price.  I know that bull call spreads are much more appropriate, and not only will provide better returns, but provide a limited form of protection against my call.  If I lose my premium on my lower strike price call, I can collect the premium on the higher price getting a "rebate" or insuring my losses up to X. Also, the breakeven point is a lower price, and I'm also protected against theta(time) decay or paying too much on a stock with high IV.  What's more, it will give me more conviction and confidence as it will help prevent me from selling too early as I would with just a call, due to my worries about theta(time) decay.

    In my situation, A level 3 is much better.  I'll probably apply for a level 3, but I'm not sure whether or not I would qualify based on federal qualifications, even though I completely accept all risks.

    I know that the regulations are probably in place to protect people who don't know what they're doing from losing a lot and suing, but personally I think that IF you don't meet the qualifications, you should still be given the chance to take some test to prove your knowledge is adequte. Not to mention, the applications are really no different then half the California bank loan application pre bubble crash, "stated net worth" and income, etc...newsflash, people out there do lie.   I don't intend on doing so, but the real unfair thing is that this so called "fair" rule, punishes the honest who are well informed, and perhaps also punishes the uninformed and unprepared investor anyways, particularly those that lie about their net worth.  Not to mention so called net worth can easily be manipulated.  I could probably get a loan and buy a house rather than live with my parents and my net worth would go up. However, the income that I get to keep in my pocket at the end of the month goes down, and although I have more available credit, I'm in a worse position financially, particularly if I overpaid for the house.  I could buy a deprecciating asset like an expensive new car on credit and my net worth goes up, but the real value goes down.  In my opinion, that means nothing as to whether or not it's financially appropriate for me to be a level 2 3 4 or 5.

    But I digress. Does anyone know if there's anywhere that says the general requirements are for each level of option account? I'd really rather not spend the time to send in more information requesting a level 3 option account if I'm not going to qualify, and if I don't, I want to know how much more "networth/time investing/etc" I need before I try again.

    Posted by OldFart on June 30, 2008 (04:50PM)

    OptionA - the way I understand it, the fedreal requirements are more like "know your customer" type of rules. It is up to each broker and their compliance department to develop the procedure and implement it. There are option brokers out there (I mean US based) that have no option levels, everybody is on the same playing field.

    One way to get approved for a certain level may be to send a request and enclose a letter - something in the spirit of "I have XXXX experience trading options and I understand and accept the risks, including loss, etc, etc " which they can use if something goes wrong

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