Selling Covered Calls and Naked Puts

[bobandsherry]

Yes, I do have the transaction download with my broker and my tax program.

However, being a careful person and suspicious of software bugs, I always verify each transaction against my own records.

The gain from option premiums is always taxed as ordinary income, so there's no harm in selling options in an IRA account instead of an after-tax account. There's no need to have more work, if one can help it.

I don't have much in IRA's, with 401K and pension while working I was always over the AGI limit to fund an IRA, so I'm limited to what I call my "fun" money account (taxable).

I used to go that route, but several things have changed my actions. First, now that I'm retired and have more time, waaaaay too many transactions/trades. And after years of comparing and never finding anything of significance I trust what is imported. Additionally, I keep my records in Quicken, pulling a daily download so I also have a second source which to compare with. If there's a difference it's minor, and sometimes in my favor. But tax on the small difference isn't worth my time to investigate.

 

[bobandsherry]

Hi @bobandsherry -
I am still wrapping my head around process of writing CC's, and I understand the concept of writing a CC to collect the premium - with the understanding that downside has unlimited risk and upside is capped by the strike.

Can you lay out an example of buying a call back? Would you typically do this if you wrote it OTM and it moved ITM at/prior to expiry?

Yeah, as NW mentioned, the downside is stock goes to $0. And well, that's same risk you have even without the CC. You can close (buy back) a call at anytime. If you do a "roll" of an option (which I do quite regularly) you are doing a "Buy" back of the original option and a new "Sell". You'd do a buy back of option if stock price is above the strike price near the end of the option expiration and didn't want to let go of the stock.

You could also do a "Roll" (which as I mentioned above is a buy of current and sell of future date option. However, that may just push the problem down the road, or as I've found it gives you time for the stock price to do a pull back.

Or sometime you just let the stock get called/assigned and move on to another stock to write options against. You may need to do that if the stock price has moved up significantly above your strike price and the cost to close the option is more than you think it's worth or want to dump into that stock.

My suggestion, start small and get an understanding. You'll make a couple of blunders, the cost of an options education. But keeping it small it's not a costly lesson.

 

[bobandsherry]

It was very early in my experience with options, so I didn't know how..

The funny part is on the last day , the stock dropped a little and so I ended up without the stock being called, and since I liked the stock, I left the new money in it.

Ah, OK. I was wondering if there was something I wasn't considering. We all learn from our experience. Looks like it worked to your benefit anyway.

 

[Sniggle]

Or sometime you just let the stock get called/assigned and move on to another stock to write options against. You may need to do that if the stock price has moved up significantly above your strike price and the cost to close the option is more than you think it's worth or want to dump into that stock.

Or, you can just play the other side, and sell cash covered puts on the stock you just lost. If the stock did not rise wildly, you can often write the puts at the price you got assigned, or even a little less than the price you got assigned, for acceptable premium (.25 to .5% per week commitment of your reserved cash is what I use).

 

[MRG]

Yes, more than once I regretted that I was "losing" a good stock, and scrambled to undo or offset the covered call. This was either by buying a new lot (this works out better than buying back the call when the call still has a lot of time value left), or by selling a put at the same price but further out a week.

Then, when the stock came tumbling back down from the cloud, I kicked myself for not sitting still and let the event unfold to my advantage.

My option trading is a form of stock and market timing. And we all know that market timing ain't easy.

PS. Or a call that gets in the money can be rolled onto another call on a further out date. I have recently done more of this. When option buyers balk at paying more for a call further out in the future, I know that they no longer expect the stock to keep rising, meaning the stock is getting to the top end of its short-term range. Then, I will not roll the option, and just sit back to see what happens.

I have been using roll a lot more recently. Last couple weeks I've been playing $25 strike on PLTR and just keep rolling it forward. Picked up a .374 premium today for a week on a <$25 investment. Now if I had manually rolled it waiting a couple hours between the buy and sell I could have doubled my premium.

 

[NW-Bound]

I don't have much in IRA's, with 401K and pension while working I was always over the AGI limit to fund an IRA, so I'm limited to what I call my "fun" money account (taxable)...

I used to have a lot more in after-tax accounts, but with expenses still in the 6 figures after ER and not being able to draw on 401k, these accounts dropped down fast while I waited for 59-1/2.

With our 401ks rolled over to IRA, we each have a 7-figure IRA account to play with. It would be even better to have the trading gain in Roth accounts, but our Roth accounts are about the same as after-tax accounts now.

I grow to like trading in IRA, because I can concentrate on making the most gain, instead of having to worry about tax and long-term cap gain tax treatment.

 

[bobandsherry]

I used to have a lot more in after-tax accounts, but with expenses still in the 6 figures after ER and not being able to draw on 401k, these accounts dropped down fast while I waited for 59-1/2.

With our 401ks rolled over to IRA, we each have a 7-figure IRA account to play with. It would be even better to have the trading gain in Roth accounts, but our Roth accounts are about the same as after-tax accounts now.

I grow to like trading in IRA, because I can concentrate on making the most gain, instead of having to worry about tax and long-term cap gain tax treatment.

Ah, got it. My wife and I have some decent 401K plans so the money has been left there. My plan are full of basically mutual type funds, but wife's account allows for investing in individual stocks, but just haven't bothered to pursue that as it's been growing on it's one quite well.

 

[rayvt]

Unlimited risk is only with naked calls. Because you hold the underlying stock, your risk is not higher than that of the stock holder who does not sell options.

The true risk is that your upside is capped but your downside is not.

The worst case loss is when the stock goes to 0. A buy-and-holder loses it all. You on the other hand has a little cash left from selling the option.

You are not going to be writing a CC on a stock that has a chance to go to zero.

 

[bobandsherry]

The true risk is that your upside is capped but your downside is not.

You can play the upside so it's not capped, can keep rolling over your calls. I've got a couple that I've "played" as it's moved up.

• 
  I have one from July 2020, stock was 75 cents, bought shares and sold quite a few $1 call contracts. It's moved up to $6 and now at $3.60. I've rolled the options forward, I'm ahead of the game if I would have bought and held, currently have a 1/22@$7 call on it. Figuring in the premiums, I'm have a cost per share of 15 cents, or pocketed 60 cents in premium, not a bad return just on the premium, plus I have a capital gain of from 75 cents to $3.60. If it should hit my $7 strike I'll be real happy I've done this with several stocks over the past couple of years when I started getting into writing covered calls.

• 
  Another example, I have shares of CCL that I bought when stock price crashed, I was writing CC on them, rolled them along the way. Not as volatile now so not worth writing a CC on those right now but pocketed some decent premiums on those and sitting with a capital gain as well.

And I would disagree that downside is not capped as only a fool would keep holding it as it drops, just close out the contract - lick your wounds of the loss (which you would have had anyway if you were holding long) - Boom you limited your loss. And even if it did drop to $0, you'd still be ahead vs. if you bought and held as you'd pocket the premium(s).

 

[bobandsherry]

Interesting, in looking at my various accounts (401K's, IRA's) they each have a slightly different twist on their holdings but each has a return so far on a YTD basis that is pretty much the same.

My "fun money" account where I am more active in the investments and doing covered calls and limited puts, the YTD return is 700 basis points better than the other accounts. I guess worth it for a part-time job. Keeps the mind and financial skills from getting dull too

 

[NW-Bound]

The true risk is that your upside is capped but your downside is not.

Of course the downside is capped. It's a bit less than that for a buy-and-holder, as I described, as the ultimate loss is when the stock goes to zero overnight. It can be as high as the price of the stock, but it is not unlimited.

When I write a call, my broker Web site always pops up a message warning that there would be a risk of "unlimited loss". That's only possible with a naked call. They make no distinction between covered calls and naked calls. Some people may see the message, and get misled.

And of course unlimited loss on a naked call means the stock goes to infinity, or at least "to the moon" as the Reddit crowd likes to say. That does not happen either.

You are not going to be writing a CC on a stock that has a chance to go to zero.

We were talking about the maximum theoretical loss, when the stock that you write a covered call on suddenly goes to zero, against your plan.

But even when a stock goes bankrupt, it does not go to zero overnight.

 

[jr6035]

Great Point!

Most of the stocks I am writing on aren't the type to dive that deep, so I don't have the $0 concern.

FIDO limits me to only writing CC's, which is a nice failsafe. As I gain more experience, I may look for more freedom.

Yes. Fidelity saves us from ourselves.

 

[JoshTrent]

I appreciate all the input in this thread! As I am learning more about Options, the past discussions make even more sense.

It seems to me that CCs & SPs would be another form of placing limit orders, but one would have the fortune of pocketing a Premium (whether your order goes through or not).

I must admit, the more I wrap my head around options, the more they make sense for different scenarios.

Thank You!!

 

[rayvt]

You can play the upside so it's not capped, can keep rolling over your calls. I've got a couple that I've "played" as it's moved up.
And I would disagree that downside is not capped as only a fool would keep holding it as it drops, just close out the contract - lick your wounds of the loss (which you would have had anyway if you were holding long) - Boom you limited your loss. And even if it did drop to $0, you'd still be ahead vs. if you bought and held as you'd pocket the premium(s).

Rolling an option is just simultaneously closing one position and opening another. The P&L of each position is whatever it is. You cannot avoid the loss of the first position by pretending that it wasn't closed out at a loss.


The downside is indeed uncapped. For every dollar the price goes down, your holding is worth one dollar less. This continues until you close out the position. You can quibble about the term "uncapped" okay. Probably a better term is "you fully participate in the downside".


You are definitely capped on the upside. Yes, you fully participate one-for-one as the stock goes up---but only until the stock reached the strike. Every dollar above the strike, you get NOTHING. Rolling to a new (higher) position does not change that fact.

 

[bobandsherry]

Rolling an option is just simultaneously closing one position and opening another. The P&L of each position is whatever it is. You cannot avoid the loss of the first position by pretending that it wasn't closed out at a loss.

So I book a loss (or most likely a smaller gain than originally expected) on one position, then have an offsetting gain in the future. I'm in this for the long game, not to assess a win or not on a per transaction basis.

The downside is indeed uncapped. For every dollar the price goes down, your holding is worth one dollar less. This continues until you close out the position. You can quibble about the term "uncapped" okay. Probably a better term is "you fully participate in the downside".

And as I mentioned, same downside as if you held the stock long which also "fully participates in the downside". However, by pocketing a premium the you lessen the downside. On my LVS example above I've already collected $1 per share, so if stock drops a dollar I'm still whole.

You are definitely capped on the upside. Yes, you fully participate one-for-one as the stock goes up---but only until the stock reached the strike. Every dollar above the strike, you get NOTHING. Rolling to a new (higher) position does not change that fact.

I can avoid being "capped" by rolling to a higher strike price and longer expiration. I gave an example of how I've done that just recently, bought stock at 75 cents and $1 covered calls. I've been rolling options for over a year, along the way and pocketing premiums. Stock is now trading just under $4 and I am uncapped still (now up to $7). And I've done that many times over the past couple of years with various stocks since I started doing covered calls. And rolling shorter duration options can be more beneficial as you pick up larger premiums in the future vs. buying a longer duration and well out of the money option initially.

And let's not forget, one could pocket $2 in premium and "give up" $1 in capital gains by being "capped" and still come out ahead of the game. I've done that as well.

And sometimes, it's a calculated risk. I've entered some stocks as an expected short play, looking at premium collected and the overall return even if it should be called. When I can pocket a premium that returns 9% for 20 day expiration (275% on annualized basis), I'll very happy even if it gets called. Ironically, LVS is one I just bought into under that assumption and my exact numbers on that transaction. I pocketed $100 for a 20 day contract, if this sits flat to original purchase price, I'll make a small 2.5% (or about 45% annualized). Or I may find that I roll this forward with a longer expiration and higher strike price, and still collecting a premium (usually the only way I roll an option to chase price). That will keep my gain from getting "capped".

And something else to consider, could be someone would buy a stock, it hit a "target" in that persons mind and they sell, and yet stock continues to go up in price. So covered call is no different on someone forgoing the additional upside because they sold too soon. It's the risk of the game, no one is going to pay you 9% return (275% annualized) without a bit of risk.

For me, investing with options is a long game. This is not just a one play in a series of downs. Maybe you lose a little on one, maybe forgive a bit of a gain on another. Ya know what, I've done that with long holds. But by the end of the game I'm ahead of the game vs if I were to buy and hold.

And to just wrap this up, covered calls don't work for every stock. Those that are expected to be movers on price can be better played with other option strategies. But that's a whole other thread perhaps

 

[bobandsherry]

I appreciate all the input in this thread! As I am learning more about Options, the past discussions make even more sense.

It seems to me that CCs & SPs would be another form of placing limit orders, but one would have the fortune of pocketing a Premium (whether your order goes through or not).

I must admit, the more I wrap my head around options, the more they make sense for different scenarios.

Thank You!!

You hit it on the head, have to consider the scenario. Covered call may not be for every stock. Or you have to assess why you are doing a covered call. Some CC may be for a decent return for a short duration. I also do CC on stocks that are strong dividend payers, I don't expect much appreciation in price, but the premiums collected double or triple the return on the stock vs if I were to just hold and pocket just the dividend. And there may be other option strategies to use instead of CC.

As with any investing, got to do your due diligence. One should not just buy a stock and write a CC based on the premium being offered. There's a reason for the large premium - and I've seen some go bust. But also seen many winners.

And sometimes you can turn a bust into a winner. CEMI is one of mine. Bought at $4.08/sh and collected 46 cents/sh, net of $3.62/sh. Over the 9 months I held it price went down to $3.28. But along the way I pocketed another $1.92/sh in premiums. By the time I closed the position, while stock was down 20% I still made $1.58/sh so 43% return on initial investment (58% annualized). So here's an example of where I "fully participated in the downside" and still had a win on the board.

 

[NW-Bound]

It seems to me that CCs & SPs would be another form of placing limit orders, but one would have the fortune of pocketing a Premium (whether your order goes through or not)...

Yes.

My style is to have only stocks with good fundamentals, in my view. Then, when I see them surge up due to a "buy, buy, buy" wave from the crowd, I sell covered calls at a price I don't expect them to hit. The premium is lower with the high strike price, but these are the stocks I hold long-term and do not want to lose.

Then, when the stocks go back down a lot, often for reasons I cannot fathom, meaning no bad news that I could detect, I would sell cash-covered puts that are also out-of-the-money, to add to the existing positions. I have to be careful here because it may deplete my cash reserve, and also cause a high concentration in a few single stocks or sectors. This can be tough when dealing with high-priced stocks such as LRCX or ASML, whose round lots cost $60K to $80K. Each contract, if assigned, has a significant impact on my AA.

Occasionally, the options get assigned, but my record is about 85-90% expiring worthless. And occasionally, a stock would surge way way above my strike price, and I kicked myself for "losing" it, and would try to buy it back. And also quite often, the stock eventually dropped way way below the price that I sold it at. And I would kick myself again for not being more patient, in order to buy the same stock back cheaper. The market is truly crazy at times.

Again, I don't count on being able to hit the highest and lowest price points. If option selling makes me more money than if I had done nothing and only held the stocks, then I call it successful.

Of course, if I held the wrong stocks such that they go down in the longer term, then the option premium may not help enough. Hence, I have to compare the overall portfolio performance to the S&P to have an objective comparison.

 

[NW-Bound]

As with any investing, got to do your due diligence. One should not just buy a stock and write a CC based on the premium being offered. There's a reason for the large premium - and I've seen some go bust. But also seen many winners...

Stocks such as Tesla have high premium for stock options, whether you want to sell calls or puts. It's because it can swing violently one way or the other. I don't have visibility into its future earnings, hence do not play this stock although it's tempting.

It's possible to hold this stock to make money from covered calls, but its nature may be that it would cause me to spend all my time following the stock. And as I never want to be too concentrated in any single stock, it may cause me to spend too much time on one stock and neglect the others. So, I pass.

And sometimes you can turn a bust into a winner. CEMI is one of mine. Bought at $4.08/sh and collected 46 cents/sh, net of $3.62/sh. Over the 9 months I held it price went down to $3.28. But along the way I pocketed another $1.92/sh in premiums. By the time I closed the position, while stock was down 20% I still made $1.58/sh so 43% return on initial investment (58% annualized). So here's an example of where I "fully participated in the downside" and still had a win on the board.

Yes, covered calls can bring in enough "dividends" to make a difference. Even if you still have a net loss on that stock, the loss is less than what it would be otherwise.

If on the average, you make more on each position than buy-and-holders, you will win. You won't get rich overnight, but adding a few percent year in/year out helps. I have been making way more on option premium than I spend each year. But then, my WR is so low.

 

[bobandsherry]

Stocks such as Tesla have high premium for stock options, whether you want to sell calls or puts. It's because it can swing violently one way or the other. I don't have visibility into its future earnings, hence do not play this stock although it's tempting.

TSLA is one stock that just doesn't follow the fundamentals or reasonable rationale for how it's valued. I had sold OTM puts (weekly), waiting after the earnings and production #'s are released, reducing the big drivers for its volatility. It was a steady stream of premiums, but right now I'm not seeing the premium/return with the risk, time, and effort. There's other "options" that are more rewarding.

 

[NW-Bound]

Lest people think writing covered calls is a sure way to make money or to beat the market, I will show this simple example that I have made before in another thread. You will see that success is not guaranteed.

Suppose you have two stocks A and B, both are currently at $100. You write a call on both of them, with strike price of $102 and a premium of $1, expiry in 2 weeks.

Before writing the calls, you have 100 shares of A and 100 shares of B, together worth $20,000.

After writing the calls, you still have $20,000 worth of stocks, plus $200 cash.

At expiry, stock A jumps to $105, while stock B declines to $95.

If you did not write the calls, you would have stock A worth $10,500 and stock B worth $9,500. Your total would stay the same at $20,000.

But with the option on stock A getting called and option on stock B expiring worthless, you now have $10,200 from selling stock A, plus stock B worth $9,500, and the $200 option premium. You now have $19,900. You have lost $100, compared to doing nothing.

With covered call writing, if you are not careful, you will lose more and more of your winning stocks, while retaining more and more of your losing stocks. It can set you back.

 

[RobbieB]

Yeah, it set me back 10 grand before I didn't do that stuff anymore.

 

[rayvt]

But with the option on stock A getting called and option on stock B expiring worthless, you now have $10,200 from selling stock A, plus stock B worth $9,500, and the $200 option premium. You now have $19,900. You have lost $100, compared to doing nothing.

At closing, stock A is worth $10,500 and stock B is worth $9500.


But you only got $10,200 for A. The extra over the strike is lost to you, because your upside was capped at the strike.


But on B you got all $500 of the loss. Because you fully participate in the loss.

 

[JoshTrent]

TSLA is one stock that just doesn't follow the fundamentals or reasonable rationale for how it's valued. I had sold OTM puts (weekly), waiting after the earnings and production #'s are released, reducing the big drivers for its volatility. It was a steady stream of premiums, but right now I'm not seeing the premium/return with the risk, time, and effort. There's other "options" that are more rewarding.

So far in my Options journey, I recognizing that increased Volatility translates to increased Premium. Care to share how you evaluate stocks as CC potential?

As a neophyte, I am currently writing CC's on long positions I already have in my portfolio. Once I have my feet under me, I plan to allocate a specific portion of my portfolio to options, and will be seeking out equities specifically for Option Positions. Any resources you suggest? (books, websites, blogs, etc.)

 

[Sniggle]

At closing, stock A is worth $10,500 and stock B is worth $9500.


But you only got $10,200 for A. The extra over the strike is lost to you, because your upside was capped at the strike.


But on B you got all $500 of the loss. Because you fully participate in the loss.

So you then write a CC put on stock A at the price it was assigned away (or alternately, you do a 'buy write call' if you are convinced it will go up more and you want more of the upside), and you write another covered call on stock B.

This strategy will not always move you back into the black, but it will succeed quite often.

 

[JoshTrent]

Lest people think writing covered calls is a sure way to make money or to beat the market, I will show this simple example that I have made before in another thread. You will see that success is not guaranteed.

Suppose you have two stocks A and B, both are currently at $100. You write a call on both of them, with strike price of $102 and a premium of $1, expiry in 2 weeks.

Before writing the calls, you have 100 shares of A and 100 shares of B, together worth $20,000.

After writing the calls, you still have $20,000 worth of stocks, plus $200 cash.

At expiry, stock A jumps to $105, while stock B declines to $95.

If you did not write the calls, you would have stock A worth $10,500 and stock B worth $9,500. Your total would stay the same at $20,000.

But with the option on stock A getting called and option on stock B expiring worthless, you now have $10,200 from selling stock A, plus stock B worth $9,500, and the $200 option premium. You now have $19,900. You have lost $100, compared to doing nothing.

With covered call writing, if you are not careful, you will lose more and more of your winning stocks, while retaining more and more of your losing stocks. It can set you back.

Thank you for laying out this scenario.. the example you provided lays out a situation of which I hadn't put thought to.

Other then selling Stock B for a Loss or holding for a break even on its own, is writing a CC at a strike of $100 (original purchase price) a viable choice? I suppose one's opinion of Stock B would need to be taken into account..