Think About Writing Your Covered Calls Earlier

by Wayne Ferbert on May 14th, 2012

Lots of investors like to use covered calls to generate extra income for their portfolio. It is a very popular strategy among investment advisors to help lift the returns for their portfolios. If you are a Buy & Hedge client and you use collars, then you already use this strategy as it makes up half of the collar tactic.

It is options expiration week. This Friday, the standard May options will expire. If you regularly sell calls around the expiration date every month, then this month might present you with an interesting opportunity.

If you sold the covered calls around April 20th last month, then you most likely have a raft of covered calls in your portfolio that are nearly worthless. Having covered calls expire worthless is always great. But in this case, they are worthless because all of the broad market indices are down 2.5% since April 20th. So, your underlying stock or ETF has lost more value than you made in the call. Not a great feeling – but no use crying over spilled milk.

Here you are one month later facing another expiration this Friday. It is time to look at selling the call again. We have a thought for you to consider. Go ahead and sell the calls for June now – before expiration on Friday of your May calls. But don’t buy back the May calls. Just let them go ahead and expire on Friday. So, between now and Friday, you will have twice the number of calls that you are short in your portfolio.

More than likely the May calls would cost you at least a couple of pennies to close them out by buying them back. But don’t bother. There is no need to give the market back those pennies when you can just keep them.

You can sell the June calls ahead of the May expiration if you have a margin account and have full options approval (including ability to sell naked calls). As a result, this strategy won’t work in an IRA account.

The June expiration is 5 weeks away starting today. You usually collect a little more premium for the 5 week month versus the 4 week month. Volatility has been creeping up of late – making all options more valuable. You should be able to find a strike you can get comfortable with this week.

Realize your new risk profile: You have X number of shares and you have sold 2X the number of options contracts in out-of-the-money covered calls. In other words, you have sold a naked call. For this week, between now and Friday, you have risk that if the market rockets up, you could actually have a position that loses you money.

In fact, technically, the covered call you just sold could lose an unlimited amount of money. Of course, when does the market ever go to infiniti. Last month when you sold the call around April expiration, you sold it out of the money (maybe around 5% upside, for instance). Now, the market is down 2.5% since then. So, the call you sold last month is about 7% out of the money. The market would have to move 7% in a week for you to even start to lose money. That would be quite a week given the current market dynamic we see.

Just realize the exact trade you would be placing: you would be predicting that the market will not rocket up 7%+ in only 5 days. Given the current market climate, my bet is that many of you can get comfortable with a trade like this.


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1 Comments

Covered Calls - October 8th, 2012 at 1:03 AM
Great post%u2026 its really helping me alot..
thanx for sharing it..


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