Why not just write OTM covered calls on your stocks

[wwatson1]

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 ...

i agree, you could always add to your position at a better price aswell, average in

 

[smallfil]

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.

For one thing, since, this is an OTM call option, the premiums you collect will be small relative to the risk. The risk being your stock dropping far below the cost of the premium which gives you a very limited amount of downside protection if at all. So, you end up losing monies. Another of the risk is the stock runs up big, you are left getting your paltry returns and your return capped to the gain you had up to the option strike plus the cost of premium. Atleast, in this scenario, you made some monies. And if the stock gaps down big for any reason, you have lost a huge amount. So, you are in effect risking a lot more in exchange for the paltry options premium you receive.

 

[Robert Morse]

I have provided my opinion on buy-writes before. I hate them. If I'm to spend time and effort to pick out 6 to 10 stocks I think will well outperform the market, why would I want to cap my gains on the few times I'm correct with OTM calls that typically trade at lower prices. To me, the math does not work. If that stock moves 20%, I'm not looking to exit just because it is up 20%. In fact, I might like it more than before and want to buy more. Then I have other stocks that went down and my only protection was those calls?

Not for me.

 

[zedDoubleNaught]

For one thing, since, this is an OTM call option, the premiums you collect will be small relative to the risk. The risk being your stock dropping far below the cost of the premium which gives you a very limited amount of downside protection if at all. So, you end up losing monies. Another of the risk is the stock runs up big, you are left getting your paltry returns and your return capped to the gain you had up to the option strike plus the cost of premium. Atleast, in this scenario, you made some monies. And if the stock gaps down big for any reason, you have lost a huge amount. So, you are in effect risking a lot more in exchange for the paltry options premium you receive.

Given this comment, it sounds like, I'd have to hold the stock for the whole time I have the covered call, and I have to hold the covered call until the expiration to collect the premium. So, if the stock dropped with 2 weeks to go until expiration, I wouldn't be able to sell the stock; or, I'd have to close the call, then sell the stock, which would mean losing the premium. Is this correct?

 

[Robert Morse]

You can unwind the position whenever you want. That is not the point. The point is that it is hard to pick stocks that go up more than the market. Why sell calls to limit your gains on the winners for a small premium today? Yes, you get the keep the call value on the stocks that go down and sideways. If that is your expectation, the stock buy was a loser and you had a lot of risks.

This is just my opinion. Many investors like buy-write. I do not.

 

[motterpaul]

For one thing, since, this is an OTM call option, the premiums you collect will be small relative to the risk. The risk being your stock dropping far below the cost of the premium which gives you a very limited amount of downside protection if at all. So, you end up losing monies. Another of the risk is the stock runs up big, you are left getting your paltry returns and your return capped to the gain you had up to the option strike plus the cost of premium. Atleast, in this scenario, you made some monies. And if the stock gaps down big for any reason, you have lost a huge amount. So, you are in effect risking a lot more in exchange for the paltry options premium you receive.

If the stock gaps down your covered calls MAKE money. A covered call is "sold to open" (to someone buying your calls for your shares) meaning you are on the short side of the trade.

I like covered calls because I can often watch the stock gap down, close my covered calls, and then the next day watch the stock come back and open my covered calls position again. That way, I made money, closed the options, and the stock is back to where it was. It is not a bad strategy, really.

The only bad time is when the stock goes UP and your covered calls have kept you from reaping the benefit. That is why they are better as short-term plays, not a long-term position.

 

[destriero]

Your calls likely make money... what of your stock?

The only bad time?

A covered call is a synthetic short put. So down is bad. Down with an increase in vol is worse. Vol trades inverse to the market. Imagine that.

 

[Robert Morse]

If the stock gaps down your covered calls MAKE money. A covered call is "sold to open" (to someone buying your calls for your shares) meaning you are on the short side of the trade.

I like covered calls because I can often watch the stock gap down, close my covered calls, and then the next day watch the stock come back and open my covered calls position again. That way, I made money, closed the options, and the stock is back to where it was. It is not a bad strategy, really.

The only bad time is when the stock goes UP and your covered calls have kept you from reaping the benefit. That is why they are better as short-term plays, not a long-term position.

In all my years of trading, there was never a time when I bought stock with a 100 delta, sold an OTM call with a 25 Delta or less 1:1 and hoped the stock dropped so I can make money on the short call and cover. To me realized and unrealized P/L are equal except for taxes.

 

[smallfil]

If the stock gaps down your covered calls MAKE money. A covered call is "sold to open" (to someone buying your calls for your shares) meaning you are on the short side of the trade.

I like covered calls because I can often watch the stock gap down, close my covered calls, and then the next day watch the stock come back and open my covered calls position again. That way, I made money, closed the options, and the stock is back to where it was. It is not a bad strategy, really.

The only bad time is when the stock goes UP and your covered calls have kept you from reaping the benefit. That is why they are better as short-term plays, not a long-term position.

What if it gaps down instead and you are down $10 or $20 on the stock and collect how much $2 in premium? That would make sense if the stock does not go down. If it drops a tiny bit, and your premium can cover the loss. Other times, you take a huge loss.

 

[newwurldmn]

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 ...

Why would you sell the upside you should be betting on?
If you aren’t betting on that upside, why are you Long the stock in the first place?