Option Trading College
 

Subject: Covered Calls
Instructor: The donFranko
Length: 6 sessions

 

 Training  Home

Entry is Key...Exit is Everything! TM

Session 1 -- Covered Calls

Do you want to make consistent and predictable returns each month? Executed properly, you can conservatively make 1% - 3%, or for a more aggressive style of trading, you can possibly make as much as 5% to 10% month on the stocks you already own. Many investors do not know they can actually start collecting premium (rent) on their shares and instead watch their portfolio values swing up and down, down, and lately down some more accepting it as the way things are. Well, I am here to inform you there are option strategies you can employ that can save your portfolio value and in some cases, make you more money than you lose in value.

If you take the time to learn this valuable technique, you just might be able to do something exciting like: buy a new car, boat, house, gifts or donations without spending any of your own money! Compare that to the paltry returns you get from other passive investments like CD's or Mutual Funds and the skies the limit!

The technical name for this strategy is writing covered calls. Writing, in laymen’s terms, means you are selling the right for your stock to be purchased by someone else; and in return you are getting paid a premium (rent)  for offering up your shares at a predetermined price.

The goal is to collect premium and NOT have to sell your stock. This takes some homework on your part and you should be conservative in your approach to avoid having your shares sold.  

Trading (Start Here)

 

Controlling Losses

 

Calls

A month in the life

 

Puts

A month in the life

 

Day Trading Intro

Charting

Covered Calls

L.E.A.P.S.

Spreads

Naked Puts

Naked Calls

Compounding

Pair Trading

 

PORTFOLIOS

 

Model Portfolio

Day Trades

Lotto Trades

 

Members

Training Links

 

Bull/Bear 180's

Day Trading

Risk Free Trading

Hit Options Lotto

 

Session 2 -- Example of a Covered Call

Here is how it works. First off, you look at the stocks you own or for a stock that you would like to own. Next you look for that stock to bounce off a known support level and start to move higher (see Charting 101). We will use a nice steady stock, General Electric (GE) as the example.

At the time of this writing (6/09/09), (GE) is trading at approximately $13.50 per share and appears to be hitting resistance at $14 per share. Plus, it's been in a very long down trend and has retraced back to resistance from a market bottom.

Note: the best charts to look at are Monthly charts since you

are selling options that expire month to month.

Looking at today's options we have the following call premium opportunities:

Typically, you should already own the stock you plan to sell covered calls on; and you should have some profit in this stock  before you start looking to collect some premium (rent) on your investment. The idea is to collect premium and not have your stock called away from you, so the conservative route is to sell out of the money (OTM) when your stock is at strong resistance levels and you anticipate a drop in price back to a support area, that way, when the stock pulls back your option premium collapses and you keep the money you took in.

For a more aggressive approach, you can sell at or in the money (ITM) to pick up more premium, but you risk having the stock rise above your strike price at expiration and having your shares called away; however, if you do not care about that, you can just sell whatever strike price can pay you the most premium to capture that "rent".

Of course, if the stock does get called away, then you have created a capital gain; and depending on how long you have owned that stock, you will incur tax consequences; so the wise investor does not want to necessarily risk that, and only sells covered calls on stocks they have profit built into that has a low potential of being called away.

Looking at the examples above, I would say selling the July 15.00 strike would be conservative; and doing this transaction would give you $0.27 cents per share in premium (rent).

Note: whenever you sell a call, you always get the premium at the "Bid". Also, you will pay a commission for the trade, so you really need to have enough shares to cover all of that and still make a profit. In order to make this a worthwhile strategy you should have at minimum 500 shares but preferably 1k shares or more works best.

For example:

500 shares of GE would have a cost basis of $6,790. You would sell 5 contracts of the Jul 15 calls and collect .27 per share or $135.00. At my brokerage, the cost of that trade would be $7.95 plus $1.00 per contract or $12.95 giving me a potential profit at expiration of  $122.05. On a percentage basis, I would make approximately 1.8% on my invested dollars so long as GE stayed under $15 per share by the July expiration. Not bad for a month, and if I did this every month, I could potentially make 20% on my money annually and still have my original investment in the stock. Each time I successfully do this, I am reducing my cost basis in my stock building more profits. Plus, because GE pays a dividend, I am able to collect that so long as I do not have the stock called away before the Ex-dividend date.

Session 3 -- Concerns

What if I want to keep the stock?

If it looks like the stock is going to break out of a resistance area, then you can buy back the calls and hold onto the stock so you do not create a taxable event on your stock purchase. This is why you need to be conservative on your trades and only take trades that have a high odds opportunity to work out. If things do not work out then you would have to buy back those calls at a higher cost than you sold them and try again when the stock calms down.

However, I would not sell covered calls on a stock I thought was going to break out. Also, I would not recommend selling covered calls on any stock you would not want to own in case it goes down or shoots up rapidly at the time you execute this type of strategy.

It's best to buy solid companies and wait until you have a profit in your stock before you start applying this strategy; and I would certainly not recommend doing this on volatile stocks or during earnings announcements.

Session 4 -- Tweaks On Covered Calls

Here is another tweak on this type of strategy.

If you do get the stock called away from you, and you still like the stock at those higher prices, but its near a resistance level, then just sell a naked put and take in more premium hoping the stock actually drops back down and gets put to you.

If the stock falls in price before expiration, and it's trading below the strike price you sold the naked put at, then you will have the obligation to buy that stock at the strike you sold and you get to keep the premium you took in from the put! This means you get paid to buy back your stock.

Here is an example:

 

GE is now trading at resistance and you had your shares called away from you at $13.00 last month, but you want to buy them back; however, it's moved up in price and you do not necessarily want to pay that higher price at this time. By selling the Jun 13 puts you would get paid $0.19 per share in premium or $95.00 minus commission; and if GE pulls back below $13 on or before expiration; then you will be obligated to purchase the stock at $13.00 per share. (Note: if the stock trades down or below your sold strike price before expiration, you could have it put to you early, so be sure you want to own this stock.) Now if GE continues to move higher, you will not have to buy the shares, but  you keep the premium!

The downside is since you do not have your shares anymore, you missed out on some price improvement, but that really is not that bad since you can keep selling naked puts and collect premium until you do get your shares back; and once you have them, you just start selling covered calls again and continue to collect more premium!

The biggest challenge with this naked put selling is brokers usually require that you have $50k - $100k in your account and extensive experience trading options. You can talk with your broker about this; and if you show that you are only willing to do it on stocks you own, they may allow you to do it with a smaller account since their risk would be minimized.

So, if you are able to combine these two strategies, you can make some nice extra income on solid stocks you already own instead of watching them bounce around all year.

 

Here is another way to do covered calls without actually owning stocks. You can purchase LEAP options, and then write covered calls against those LEAPS. This takes more work because you do not have the underlying security to be delivered to the buyer of those calls, so you have to be very conservative on how you do this. If you make a mistake or get too greedy, then you are obligated to purchase the stock outright and deliver that stock to the buyer of the calls you sold. I highly recommend you do NOT do this tweak until you are seasoned and you have the capital to cover any trades that go wrong; however, if you are very conservative, you could ultimately reduce your cost of the leaps to zero over the course of a couple of years.

I would not recommend selling covered calls or naked puts on highly volatile Internet type stocks unless you have an iron stomach and can pretty much be a full time trader watching it. In fact, just stick to the slow movers and you will be much happier.

Covered call writing is a conservative strategy for collecting premium (rent) on your stocks and not meant for high risk trading styles.

Session 5 – Account Protection tactics   

Here is another way to save your account value and possibly make a bundle of extra profits along the way. This twist works best on more volatile stocks so if you own shares in hot stocks like AAPL, GOOG, BIDU, CMG etc. then you should consider this to protect your future value. Stocks like these have very large swings in price year-to-year and rather than watching your portfolio value swing up and down in value, you may be able to maximize things.

I have a friend who happens to own 4,000 shares of AAPL and has no idea how to use his massive leverage to make a boat load of cash. Apple is a very volatile stock and over the past few years his portfolio value has swung up and down close to a million dollars. He has held onto his shares since his early 20's and because of splits he has grown his shares to 4k last I spoke with him. The sad thing is he is clueless about options and therefore has reservations about applying these tactics. When I found out he had that many shares I told him to learn about this tactic so he could protect his portfolio value. Well, he did not choose to do that and shortly after our meeting, AAPL took a turn for the works and dropped over $120 dollars in value. He was dang near a millionaire on paper one year and the next was was a multi-thousandaire.  Now had he learned how to leverage his stock with Covered Calls, he could have made thousand of dollars as the stock dropped and tens of thousands more if he employed this tactic I am about to reveal.

Well, that was back in 2008 and now its 2012 and AAPL is at all time highs. He is now close to being a milti-millionaire on paper, but with the stock at these massive highs, there is a very strong possibility AAPL could take a turn and head back down to the 200 price range. Who knows, but now that he's getting older he needs to consider protecting his portfolio value before he loses hundreds of thousands of dollars again.

The smart strategy here is to watch for AAPL to lose value at a resistance level and then sell covered calls to collect the premium; however, rather than pocket the cash, you invest it in OTM puts that way, If the stock take a turn for the worse, you will lose a lot less portfolio value, because the puts you picked up for FREE will have the potential to become very profitable.

Tomorrow is Apple's earnings report and if they miss, this stock is going to see some lower prices. Even if they beat, the current run up in price will most likely create a "sell the news" event and still head lower. Either way, he stands to lose portfolio value if he does not take proactive action to mitigate it. It will be a sad day for him, if APPL starts to drop from these lofty highs and NEVER returns . It will be tens of thousands of dollars lost that he will not be able to recover for a very long time...if ever. Then again, the stock could just continue to climb in value, but you have "nothing" until you actually sell, so why not learn how to collect rent along the way and maximize your investment.

Here are today's option prices:

Now we will wait until earnings are announced and see where the stock ends up before we make a covered call play with married puts.

 

Session 6 – Lazy mans way to collection rent

Here is another way to do covered calls without actually owning stocks. You can purchase LEAP options, and then write covered calls against those LEAPS. This takes more work because you do not have the underlying security to be delivered to the buyer of those calls, so you have to be very conservative on how you do this. If you make a mistake or get too greedy, then you are obligated to purchase the stock outright and deliver that stock to the buyer of the calls you sold. I highly recommend you do NOT do this tweak until you are seasoned and you have the capital to cover any trades that go wrong; however, if you are very conservative, you could ultimately reduce your cost of the leaps to zero over the course of a couple of years.

I would not recommend selling covered calls or naked puts on highly volatile Internet type stocks unless you have an iron stomach and can pretty much be a full time trader watching it. In fact, just stick to the slow movers and you will be much happier.

Covered call writing is a conservative strategy for collecting premium (rent) on your stocks and not meant for high risk trading styles.

 

Profits Up!

The donFranko 

 

If you feel that I have taught you a valuable lesson, then consider Subscribing to my members only site for access to my live portfolio's, daily suggested plays and my Lotto Trades!

 Calls | PUTS | CHARTING | COVERED CALLS | l.e.a.p.s  | spreads NAKED PUTS | NAKED CALLS | PAIR TRADING | Training 

Home

©1999-2016

www.OptionRadio.com
All rights reserved.

 

Privacy Statement  Terms of Service  Disclaimer

 

Contact Us About Us