Covered Call Strategy

[Greymalkin]

Does this make sense as a strategy:

Let's say I own DDD, bought 100s at $40. I like the stock, don't want to part with it, think it'll see $100 some day.

BUT, there's a ton of volatility with it and I figure I can profit from it using covered calls. So I go and SELL OTM Calls, 3 months out at a time. So, say August 60 calls.

I SELL the Call, and pocket say $200 (making up a number, I don't know what it actually is). I'm pretty confident that DDD won't hit 60 by August, therefore I get to keep my stock AND pocket what I sold the Call for.

Come August, DDD is at, say $58, so I go and sell a November $70 Call. Rinse and repeat every 3 months.

I'm selling a call I'm confident that DDD won't reach and therefore be called away. And at some point, if they do get called, it'll be at a price point I'm making a good return on.

Does this strategy make sense?

 

[butterfacetrader]

Gotta factor in tax events. Say you don't want a cap gain that year, then you don't wana be in a position to be called away causing a sale or have to close an options position at a loss.

But otherwise, yes, if you're going to own stock, you may as well sell a call too. The problem with this often is it limits your gains, but helps protect a limited downside. DDD specifically has no dividend yield so at least the covered call is generating 'something'.

On the flip side, if DDD goes to $100 and your call is $60, you've lost $40 of upside and collecting only $100 premium for your 100 shares.

Pros and cons.

 

[Greymalkin]

Good points. Thank you.

 

[drownpruf]

Nobody cares where you bot the shares. It's at $54 and the $60s are $2.10 bid out to Aug. There are better methods by which to short vola, but short puts are fine.

 

[butterfacetrader]

Another way to do it is to buy protective puts.

Say you are sitting on a healthy 5% or more gain. So you buy puts to protect your position at or slightly above the strike of your cost base, or equivalent, so you have no capital risk anymore for that duration, and just let DDD go as high as it can, and if it goes lower you're fully protected.

Won't work if you are sitting in a loss immediately after entering a position. In that case, selling calls helps you slowly climb back out of a hole, if luck permits.

Difference in philosophy is covered calls means limited possible gain but full downside loss of all invested capital. With protective puts initiated after sitting on capital gains already, you limit risk and allow uncapped upside. Different strokes for different folks though. Depends how nimble a trader you are at identifying price action on what to do.

 

[Greymalkin]

Another way to do it is to buy protective puts.

Say you are sitting on a healthy 5% or more gain. So you buy puts to protect your position at or slightly above the strike of your cost base, or equivalent, so you have no capital risk anymore for that duration, and just let DDD go as high as it can, and if it goes lower you're fully protected.

Won't work if you are sitting in a loss immediately after entering a position. In that case, selling calls helps you slowly climb back out of a hole, if luck permits.

Ah, okay. So let's say I've bought DDD at $40, and it's now at $54. You're saying buy the $40 put at this level to protect my gain?

 

[butterfacetrader]

Ah, okay. So let's say I've bought DDD at $40, and it's now at $54. You're saying buy the $40 put at this level to protect my gain?

This is not a recommendation.

If it was me, and I purchased DDD at $40 and now its $53.97. I will probably go out to Jan16'15 $45 strike put for around $5/contract.

In doing so I am fully protected from suffering any capital loss from my initial invested capital (initial capital is $4000 per 100 shares), and I allow full upside of DDD for that duration. If it goes lower than the $45 strike, my net net of exercising the $45 strike put gets me back at $40 cost of sale for the 100 shares, which means no gain no loss.

On the other hand if I'm conservative, I could sell a call at $60 and collect around $4/contract. But doing so I fully risk all my invested capital of $4000 per 100 shares, and limited my gains.

Ultimately you have to determine for yourself where you think price will go and depending on your style go with what you like. There is no right or wrong way to do it.

It should be mentioned you can sell covered calls and also do protective puts too. If you time market and price really well, then yes, your scenario is correct, You can keep rolling covered calls higher and higher and capture yield without selling shares. But nobody is every that good. More often than not the market will gap past your strike and you are out of the game with limited gain.

 

[drownpruf]

Another way to do it is to buy protective puts.

Say you are sitting on a healthy 5% or more gain. So you buy puts to protect your position at or slightly above the strike of your cost base, or equivalent, so you have no capital risk anymore for that duration, and just let DDD go as high as it can, and if it goes lower you're fully protected.

Won't work if you are sitting in a loss immediately after entering a position. In that case, selling calls helps you slowly climb back out of a hole, if luck permits.

Difference in philosophy is covered calls means limited possible gain but full downside loss of all invested capital. With protective puts initiated after sitting on capital gains already, you limit risk and allow uncapped upside. Different strokes for different folks though. Depends how nimble a trader you are at identifying price action on what to do.

So he buys the synthetic call spread, why?

 

[drownpruf]

Ah, okay. So let's say I've bought DDD at $40, and it's now at $54. You're saying buy the $40 put at this level to protect my gain?

It's a married put at $40. It doesn't protect your gain. It offers a stop at the strike (less premium).

 

[butterfacetrader]

So he buys the synthetic call spread, why?

The same reason why anyone makes a bullish bet with a call spread. You don't mean to tell people there are only some ways to make trades now are you?

In the quote you quoted, there was no synthetic call spread. Just a synthetic call.

The synthetic call spread will be in my latter post where I described doing a protective put and selling a call also.

In any case, actually, the difference between doing a call spread and the situation he is in, is that he is now sitting on cap gains already. Which means the position he puts on is free. Someone who goes out and does a debit bull call spread spends money and risks that. He risks nothing relative to his initial capital. Further, OP seems to want to obtain yield by rolling calls, with a mildly bullish sentiment and expectation that DDD continues an upward trend.