Welcome to the board, AZ. I think.
Also, I was planning on writing covered calls against the shares of stocks (out of the money) to generate extra cash to invest along the way. Does this sound too risky or crazy?
Doesn't this seem a bit like going from zero to Mach 2? You're carrying some debt, you don't even have any savings, and you're already looking at selling options on shares you don't yet own.
A majority (perhaps a vast majority) of the board's ERs got that way by saving-- not by owning their own businesses or by cashing in options or by brilliant investing. They didn't use covered calls, either. They set a budget that matched their values, they saved a huge percentage of their paychecks, they developed an asset-allocation plan that they could stick to, and they invested in low-cost index funds. They bought & held as long as possible to minimize taxes. They maxed out their 401(k)s and IRAs, they learned a lot of DIY skills to save on home/auto expenses, they did most of their shopping on Craigslist or other bargain basements. Sometimes they even gave up shopping and did without. They spent a lot of time tracking their spending & investing with spreadsheets, Quicken, FIRECalc, and other financial/retirement calculators. A few of the extremists went without modern material entitlements like cell phones and cable TV. They also debated whether to scoop up cheap real estate, if that matched their interests, and whether to support any of their kid's college expenses (let alone private schools). None of that may be as interesting as pricing options, but judging from the board's demographics it apparently works a lot better than selling options.
Maybe you should start with those basics and acquire a few thousand of those shares you're considering using as covered-call collateral. It'll certainly give you time to study up on the subject... after you develop the budget and the asset-allocation plan and get out of debt, of course.
The problem with covered calls is that you're giving up some of the chance of future long-term capital gains in exchange for a little bit of cash that'll be taxed as short-term capital gains. You'll also be going up against professional options traders in a market that's illiquid, subject to extremes of psychotic hype, and so volatile that it defies consistent mathematical modeling of that concept.
For the next 15 years, your ER will be built on consistently buying shares (to your chosen asset allocation) whether the market is going up or down. When the market goes down, you'll cheer about getting cheap shares. When your assets unexpectedly explode in value, you'll harvest those gains by rebalancing back to your asset allocation. If you hit a stock or a fund that goes up 20-30% in a year, you'll keep all the profits. But if you've been selling covered calls on those assets, then you'll wave bye-bye to at least a third of those profits and you'll pay short-term cap gains taxes on your own remainder.
Having said all that, I write OTM covered calls against a few shares of our ER portfolio to generate extra cash. Spouse and I started doing it as a way to force ourselves to take a little cash off the table, because we're reluctant to rebalance. I only write against shares that we've owned for more than a year (long-term cap gains). I read
McMillan's textbook along with a half-dozen others, I read a number of website tutorials, and I followed a few options traders' discussion boards/blogs for a few months. The McMillan book was the most worthwhile reference of the bunch.
If you're planning to write OTM covered calls, then don't needlessly give away your upside. Write just a few contracts on the shares that you'd have to sell to rebalance, and write the strike price at or a little above your rebalancing price. (Ideally that strike price is also 10-15% out of the money, but good luck finding that.) Think about writing them in the early part of the year to take advantage of summer seasonal slumps, if you believe that's a reliable indicator. If those shares don't go zooming up in the next few months then you're happily pocketing a little extra cash, woo-hoo! If they do zoom up past your strike then you were going to sell them at that price anyway, dammit, and never would have owned them above the strike price.
I've been writing covered calls at an $85 strike on Berkshire Hathaway "B" shares for Jun & Sep. (We've held these shares since 2001-2 at a split-adjusted price of about $41-$46.) I sold a few more at $90 to some poor fool for Sep, and if I turn out to be the poor fool then I'll be selling a lot more than the shares that get called away. The contracts are covered by shares that I'd be selling anyway to rebalance if the stock reached that price.
Next month or two I'll take a look at the Oct/Nov prices and think about selling more, or not. This stock is new to the options market, pricing is still pretty volatile, and a lot of newbies are making the market more liquid than usual. I think I know how the share price will move over the next six months and if I'm wrong then I'm rebalanced.
I've also sold covered calls at a $60 strike on the iShares small-cap value ETF (IJS) for Aug. I started selling the calls when the share price was in the mid-50s and I couldn't believe that it'd go much higher. Today it closed above $66 (even ex-dividend), so we'll have to see if the price is still there in Aug. I've already sold some shares at $66 to rebalance and we don't mind getting exercised on the additional shares at $60. But I'll be much happier selling those covered calls when the market flattens out a little... gaining this much share price in just a couple months seems a little richly valued.
Selling covered calls seems like a pretty straightforward way to make money, but your profits are barely linearly proportional to the effort you expend for them.
. Welcome to the boards!
