Why not just write OTM covered calls on your stocks

[ironchef]

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.

Many of us newbies, me included, started this way and you might as well try it out and see if you like it. Just be aware it is the same as a short put: Limited gain and unlimited loss (limit to underlying goes to zero).

The most basic question you want to ask yourself is if I like a stock, why do I want limited gain? OK, you say, if called I will buy it back, rinse and repeat. What if after you buy it back it drops? OK you say, I will continue to sell covered call at a lower strike price. Then it recovers and you are called away at a price lower than what you bought it at.... And you also pay taxes on your gain.

I still trade covered calls and cash secured puts but I don't do it mechanically to earn "extra income".

 

[taowave]

Here's your real issue. By selling covered calls,you are essentially setting a profit target(and reducing delta). In your case,your upside is limited to the percent out of the money plus the premium received.Lets just say your target is 25%.

If you are setting a target(max profit),how much are you willing to risk on each trade?You appear to be buy and hold.

I typically do not like to limit the upside without limiting the downside,and by limit I do not mean the stock going to zero...

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.

 

[smallfil]

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?

When you sell a covered call, you have an obligation to deliver the shares if called at anytime before or on the expiration date. In addition, if the stock drops a lot beyond the premium you received for selling the call, you take a huge loss on it. You can buy back the option at any time before the expiration to close it out. If the stock goes down, you get to keep the premium as the covered call would expire worthless. However, if you bought XYZ stock at $20, sold a $2 call at $22 strike price. Then, stock drops to $15. You keep the $2 premium reducing your cost basis to $18 but, the stock is now just worth $15. So, you in effect suffered a $3 loss.

 

[viruscore1]

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?

It's all about making money on long positions. Occasionally OTM covered calls are assigned when stock price raises and pass strike price. Then sell a OTM put and attempt to get assigned, strike price can be below CC assigned price.
It's the old rental property analogy. But The whole position does not need to be in the CC, the remaining quantity can participate in the run up. Just like buying lottery tickets with pocket change, can't win unless you play. Buy and hold lol. If the dividend date is not with in range, sell CC. Remember first sentence.
Bulls make money, bears make money, pigs get slaughtered.

 

[SmokingAces]

its all about your strategy/goals/risk tolerance
if your picking high growth stocks, I would never cap them, as you need the few breakouts to pay for some of the losers...
if your trading index like spy, a 20% move in the next two years is inside the 1SD...
now if your focusing on stocks like AT&T and other Dividend heavy stocks that dont grow as they are returning capital all the time, then its a little different as over 5yrs the stock has rarely moved so much in either direction, while also returning 6% in Div... so yeah go ahead and sell a two years out, as its just extra yeild ( for ATT the furthest out is Jan 2021 598 days, and Call 40 yeilds just under 2%..

 

[viruscore1]

Many growth companies do not pay dividend, no need to hold stock. Buy calls would work also if you're totally bullish. Use synthetic long, sell put , buy call. Remember you're bullish. And may the force be with you ...

 

[taowave]

What does a dividend have to do with whether or not you hold stock???

Im sure you know that the price of a call option is affected by the dividend rate...

Many growth companies do not pay dividend, no need to hold stock. Buy calls would work also if you're totally bullish. Use synthetic long, sell put , buy call. Remember you're bullish. And may the force be with you ...

 

[viruscore1]

What does a dividend have to do with whether or not you hold stock???

Im sure you know that the price of a call option is affected by the dividend rate...

You are aware option premium is an auction, you know bid / ask ? Stock price is the same.

 

[taowave]

But that has nothing to do with the dividend....

If vol is cheap/expensive,you want predefined risk or you think the skew is favorable,thats one thing,but I dont see how the dividend rate should factor in to whether or not you buy stock or get synthetically long.

 

[viruscore1]

But that has nothing to do with the dividend....

If vol is cheap/expensive,you want predefined risk or you think the skew is favorable,thats one thing,but I dont see how the dividend rate should factor in to whether or not you buy stock or get synthetically long.

If that is case, you’re previous comment doesn’t make sense .