Good questions, Jennifer

Jennifer’s question from my previous post: LINK

There is the rub of writing covered calls: What if the stock price goes down. The answer is: depends. Primarily on what you think of the stock/company at that time. Is it down because of company news? Is it down because the market in general is down? Do I think it will recover?

I have gone through all of these over the last 5 months that I have been writing this blog. I have developed a couple of rules of thumb:

  • I try to buy slightly out-of-the-money (3-5%) covered call positions and make 3-5% per month on the option premium, 1 to 2 month options, net of commissions.
  • If the stock is called I make a little extra, if not called I want to be able to write a call again at the same strike price and make a decent return. I will not cry if I get to sell several contracts before the stock is called away.
  • If the stock falls to the point that there is little to no premium at your strike price for the forseeable future (4-5 months), seriously consider buying back the option and selling the stock.
  • Your opinion of the underlying stock/company plus what the overall market action has to determine whether you keep a falling stock on the belief it will recover or you sell and reinvest elsewhere.

Having said all of that, I believe I have held on to my losers to long in the past and try to make an early decision to sell.

As to the actual trading, it is not hard. You can go to the Trade King website and click through the screens to see what they show. Once you have an account open you can enter trades in the screens and see how they work. You get a preview before the trade is sent in so you can cancel if you want. You can also easily cancel pending trades.

Start small, pick out a trade you would like to make and see if you can get it filled at a price that works for you. If you have a stock in mind let me know and I will review some trade possibilities for you. Your questions give me good stuff to write about.

Comment answer

Jennifer asked a question on getting started trading covered calls. Thought I would post my answer again:

Jennifer,
I hope reading through this blog helps you get some understanding about covered calls. I have been reading about option trading for years, and finally wanted to give it a try so I opened an account using the funds from a small IRA I had in a mutual fund. I started with about $4000.

I think the best way to learn is to just open an account and make some trades. Once you have an account (I use Trade King) you will find trade screens set up for the different option strategies. There will also be research tools to help you find trades. I use an option screener to find stock in the volatility and price ranges I am interested in.

I have found that I am developing a strategy that works for me and my temperament. Everyone that trades has their own style. Read the blogs in my blog roll and read others that you find interesting.

Parker Drilling Announces New Contracts for Six Rigs in International Markets: Financial News – Yahoo! Finance

Rolling a call option

Just a few days ago (3/19) GIGM was at $12.37 and I wrote  an April $12.50 call for $.85. Since then the stock has moved up to the $14.30 range. The time premium of the option has dropped to about $.30 so I though about buying back the option.

I put in a trade to buy back my April $12.50 call and sell the May $15 call for a net debit of $.90. I was filled paying $1.77 for the April call and getting $.87 for the May call. Commissions were $11.20.

Does this make sense? My thoughts are that I can now participate in any stock gains up to $15 vs. my previous strike of $12.5, my sold premium is about a wash, and expiration is out another month. This will work great if GIGM keeps rising.

Covered Call Trade

One of the stocks I have been watching, PKD, made a nice move today, call premium was good, so I made a trade. I bought the stock for $9.65 and sold the May $10 call for $.65.

This give an uncalled return of 5.6% if uncalled and about 9% if called, 58 days to expiration.

I have been trading covered calls and writing about the trades for about 5 months now. My strategy is evolving as I make trades, especially as I make losing trades! I now try to find the stocks with high implied volatility that appear to be more stable than the IV numbers indicate. I look at things like profitability, PE, growth rates, and what industry they are in. I now use the volatility scanner to find the high volatility stocks in the price ranges I want to trade, then analyze the companies for more stable (relatively speaking) growing companies hidden in the garbage.

I am also looking for out-of-the-money trades to either give me a return boost if called, or the opportunity to sell additional calls on the same stock. The outcome to avoid is a stock that falls so far you are writing calls with a strike below your purchase price. Ouch! See my posts on ENCY, EEE, and MED.

I have found one bad trade has had losses equal to the profits of three good ones. I need to increase the ratio of good to bad trades, and work harder to limit my losses.

New Trades

First thing, finally unloaded the dog of MED! They came out on Friday with more bad earnings news. I originally bought the stock 1/23 for $9.75, sold today for $6.32. I did make $130 in option premium, but still a pretty bad loss.

I sold the April $12.50 call on GIGM for $.85. My cost on the stock is $12.40, so a 6.8% return if uncalled for 1 month.  I have done will with this stock so far, and the company prospects look good.

I still own TFSM, which I bought at close to $10. I think the price will continue to move up from the current $7.70. I will wait until I can get some reasonable premium on $10 strike options and hopefully sell a couple before the price recovers to above $10.

I am currently looking at two stocks: PKD and RMIX for covered call write opportunities. The options on these stocks are thinly traded and I could not get filled for either one today at prices I wanted. I would actually like to see a little price pull back before I invest.

Uneventful Expiration

Yesterday, Friday, was pretty good for me. My stock positions are starting to move in a positive direction and my two open calls expired worthless. On Monday and Tuesday I will be looking at the April and May options for new opportunities for income.

The recent pullback in the market has me thinking about the quality of the stocks I am writing covered calls on and what I can do for downside protection. My strategy is to write covered calls on stocks with high implied volatility, thus higher option premiums. I have learned I need to be very diligent about learning all I can about the near term prospects of these companies. One bad decision can eat up the profits of 3 good ones.

As far as downside protection, I think my account is still too small to be able to take any cost effective action to protect the values. Anything I could do would be just guessing. I am interested at this point in how much option premium I can earn until the stock prices recover to early February prices.