Why not just write OTM covered calls on your stocks

Z

zedDoubleNaught

I've just started looking into options, and had a newbie idea. Not sure why it wouldn't work, of course because I'm a newbie:

If I generally trade stocks, with 6-month to 2-year time horizon, and target gain of 20% - 30%, why not write a OTM covered call against the stock? Since I plan to hold the stock, I could write an OTM call option with a strike at 20% or higher than the current price, with the expectation (hope) it expires OTM, and collect the premium. It probably won't get there, so I could write another OTM call after the first expires. Or if it did get to the exercise price, then I'd be comfortable delivering my shares with the 20% gain.

I suppose the one downside would be that I'd be limited to a 20% gain, which would unfortunate if the stock doubled or tripled. But I'd be happy with that since most of my stocks wouldn't hit that, instead I'd be collecting premiums while holding my stocks for the long term. I suppose another downside is that the premium at a strike price (20% higher than current price) might be so low as to not cover the commission. Another downside could be low volatility, I might have to go with OTM strike at only 10% above current to get a trade.

How do things actually work that would make this a bad idea? I'm sure there has to some obvious flaws that everyone doesn't do this.
 
The stock can go down much further then the premium you collect. You can buy it the option back and sell another covered call at a lower strike but in general you just make up some of your loss on the stock with the premiums received. In the long term this can be leveled out but it requires 'work' and active management of your option positions.
 
yea, its a normal way of mitigating your risk as the premium recieved offsets some downside, getting good divedends helps also.

i only trade forex but ive read allot about trading in general. I say go for it!
 
This is an extremely common strategy, and usually the first options trade stockholders ever make. The only thing you have to watch out for are "black swan" events - an earnings call or some other news that takes your stock much higher - then you will lose out on the gains.

Here is another drawback - dividend payouts. When your stock pays a dividend they actually take the cost of that dividend out of the stock price. This is a good thing if it means your covered calls become more valuable - BUT, it also can mean your covered calls are cheaper than the price of the stock plus the actual dividend. When that happens someone will exercise your calls to get the stock and collect your dividend. This has happened to me.

The thing to watch is the extrinsic value of the options (the amount of premium attached to each option above the stock price). As calls go further ITM the extrinsic goes DOWN, meaning it makes more sense for someone else to buy your options if their plan is to exercise them.

The usual method for covered calls is to sell them close to the money with a close expiration, and to keep rolling them up as they expire. The ideal time frame for premium degradation is about 45 to 20 days out. So, sell your covered calls 45 days out, and then roll them up 20 days later.

Or, if you want, sell the weeklies two weeks out and roll up once a week. Just remember that options that are close to expiration tend to be the most volatile so you can have big wins but also unexpected losses. If you are watching carefully, it is best to take profits when you see them get ripe.
 
zedDoubleNaught said:
I've just started looking into options, and had a newbie idea. Not sure why it wouldn't work, of course because I'm a newbie:

If I generally trade stocks, with 6-month to 2-year time horizon, and target gain of 20% - 30%, why not write a OTM covered call against the stock? Since I plan to hold the stock, I could write an OTM call option with a strike at 20% or higher than the current price, with the expectation (hope) it expires OTM, and collect the premium. It probably won't get there, so I could write another OTM call after the first expires. Or if it did get to the exercise price, then I'd be comfortable delivering my shares with the 20% gain.

I suppose the one downside would be that I'd be limited to a 20% gain, which would unfortunate if the stock doubled or tripled. But I'd be happy with that since most of my stocks wouldn't hit that, instead I'd be collecting premiums while holding my stocks for the long term. I suppose another downside is that the premium at a strike price (20% higher than current price) might be so low as to not cover the commission. Another downside could be low volatility, I might have to go with OTM strike at only 10% above current to get a trade.

How do things actually work that would make this a bad idea? I'm sure there has to some obvious flaws that everyone doesn't do this.
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Why would you be Long stocks you didn’t think would rally 20percent?
 
newwurldmn said:
Why would you be Long stocks you didn’t think would rally 20percent?
More...
Thinking a stock would go up 20% every 6 months is a target, and maybe a pipe dream especially if youre banking on it . How often it happens is another story. Selling cover call for average 3% profit per month including dividend and capitals gains is high probability.
 
motterpaul said:
This is an extremely common strategy, and usually the first options trade stockholders ever make. The only thing you have to watch out for are "black swan" events - an earnings call or some other news that takes your stock much higher - then you will lose out on the gains.

Here is another drawback - dividend payouts. When your stock pays a dividend they actually take the cost of that dividend out of the stock price. This is a good thing if it means your covered calls become more valuable - BUT, it also can mean your covered calls are cheaper than the price of the stock plus the actual dividend. When that happens someone will exercise your calls to get the stock and collect your dividend. This has happened to me.

The thing to watch is the extrinsic value of the options (the amount of premium attached to each option above the stock price). As calls go further ITM the extrinsic goes DOWN, meaning it makes more sense for someone else to buy your options if their plan is to exercise them.

The usual method for covered calls is to sell them close to the money with a close expiration, and to keep rolling them up as they expire. The ideal time frame for premium degradation is about 45 to 20 days out. So, sell your covered calls 45 days out, and then roll them up 20 days later.

Or, if you want, sell the weeklies two weeks out and roll up once a week. Just remember that options that are close to expiration tend to be the most volatile so you can have big wins but also unexpected losses. If you are watching carefully, it is best to take profits when you see them get ripe.
More...


Thank you -- this is the type of tip and real-experience I was looking for. Very helpful !!
 
newwurldmn said:
Why would you be Long stocks you didn’t think would rally 20percent?
More...

I agree with lylec305 -- it's been my experience that what I think will happen and what actually does happen are totally different. So while I'm holding them, waiting (hoping) from them to come back, may as well make some benefit while waiting a long, long time ...
 
Yea many people do this especially for SPY(highest volume) to make an extra 5%~ return on top of the average return of the SPY which is around 7%

It takes time to learn and execute tho and of course there is still risks but if you planned to hold the SPY till retirement like most people do, the risk is pretty much psychological/emotional or just deviation. Like maybe the trader get exercised and all of the sudden they think they will just buy the pull back or wait for the market to crash and then they end up losing out worse than the person who just bought the SPY and forgot about it.

Single digit percentage of traders are successful and this strategy does not make it higher.
 
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