Selling Covered Calls and Naked Puts

[bobandsherry]

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.

Just to level set, I will say I'm not an expert on options, I've paid my "tuition" at the school of hard knocks along the way but started small so kept my "tuition" cost low. I learned a lot over the past couple of years on covered calls and consider I'm always learning. Compared to other option strategies, Covered Calls are low-risk.

You do make a good point, no one pays you a premium without risk. With a buyer and seller on each side of the transaction, one of you will be right, the other wrong.

However, I want to point out that I view your example is a single "play" in a series of downs and that may make up a longer-term game. I'd view there's game left.

For "A", one would have to decide if "A" increase was short-term or not. If it was short-term, it may be possible to roll that to a longer expiration let the stock can settle back to $100. Or you could then let it get assigned and write a Put at $100, pocket a premium and wait for it to get back to $100. Or you get back in the game, rebuy the stock, write another CC (which could also cover your $100 "loss") and keep moving on with the stock. You might want to re-assess your strategy for setting a strike price. I look at strike price being set as what I might consider if I were to set a limit price, but then getting rewarded with a premium. So, I could make a point that the $100 "loss" isn't really a "loss" due to writing a covered call, but instead due to your own calculated exit price. Like how many of us haven't sold a stock and continue to see it go up in price?

Something else to consider is once stock price popped higher, you might look to sell a Put with same price and expiration as your Call. You pocket a premium for this which can soften that "loss".

For "B", similar decision point, is this drop short-term or not. If short-term it's possible to hold and write another option, pocket the premium and wait for the stock to recover your "loss". If you think this is a longer term drop then that would be your decision regardless if this were a covered call transaction, you still have the premium in your pocket. And as I had mentioned before, it's possible to ride the stock price down yet still pocket a premium that makes it profitable.

But to your point, a covered call doesn't allow you to be reckless. Don't just go for a high premium, the larger the premium, the higher the chance is you'll be assigned. Still need to do due diligence. Should continue to follow similar strategy that you use for your overall portfolio. For me, I typically avoid writing a CC that extends into an earnings release date. I also usually avoid calls for periods with dividends (or be sure to factor). I also only write CC on stocks I would want to continue to own.

 

[Sniggle]

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..

I did this recently with GS (Goldman Sacks). Sold a cash covered put at 402.5, stock dropped to 395 where I was assigned. Sold a covered call at 402.5. Stock went to the moon and I was assigned. I made $6.15 in premium over the 2 weeks...or approx. 39% annual ROI.

Would I have done better in this situation buying and holding GS...yes. But I will take a 39% AROI any day and not look back.

As long as the stock is not crashing, you should be able to get back into the black over time by selling covered calls. Now, on that road back the stock may jump and leave you short (happened to me this week with MU), but no strategy will be free from some losing plays.

 

[bobandsherry]

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.)

There's people who use a lot of technical analysis and maybe someone else here can give their set of data points they use.

For covered calls I "keep it simple". I write calls on stocks I expect to hold or move up in price. Usually on stocks I already hold or stocks I am now interested in holding and look to increase the return. One example of that is LVS, I felt a good time to get into that stock with recovery so did a purchase and then 2 week covered call. If it gets assigned, I'm OK with the return. If it doesn't, I'm OK as I wanted to hold the stock, I'll then look at the price of Call again and decide to write again or not.

I will 99% of the time select a strike price that is OTM and then chose an expiration date based on the return. I look to avoid writing a CC that extends into an earnings release period and consider dividend payment dates too.

I don't view CC as passive, I keep an eye on them going forward and use those data points to determine if I make any changes (close, roll or let it expire).

 

[bobandsherry]

Would I have done better in this situation buying and holding GS...yes. But I will take a 39% AROR any day and not look back.

Similar to my view as well. I use CC as a tool to increase my returns. I accept that some may get called. I don't get married to too many stocks, there's always another that become another opportunity.

I view that if I never get a CC assigned I am leaving money on the table. I look at overall investment returns and compare against the S&P and if I beat that over the long term I'm ahead of the game.

 

[bobandsherry]

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..

You'd have to decide if it was short-term drop or just the new "norm". If it is, then sure write another CC. I gave an example of where I bought a stock and it kept slowly dropping in price, but premiums I collected still made it a good investment.

If you conclude that this stock is going to keep going down, then you made a bad investment decision to buy the stock to begin with, so unless premiums help cover the drop in stock price unload it. I then view that the premium I collected helps to soften the blow on that bad investment decision.

FYI, I use a spreadsheet I created to give me a quick view of the return. I screen scrape data from E-Trade and paste into my spreadsheet to quickly give a view. I look at the return for NC (not called) and Called, then decide on where I think stock price may be for each expiration and place my order. Here's a sample using LVS which I just purchased.

 

[jr6035]

There's people who use a lot of technical analysis and maybe someone else here can give their set of data points they use.

For covered calls I "keep it simple". I write calls on stocks I expect to hold or move up in price. Usually on stocks I already hold or stocks I am now interested in holding and look to increase the return. One example of that is LVS, I felt a good time to get into that stock with recovery so did a purchase and then 2 week covered call. If it gets assigned, I'm OK with the return. If it doesn't, I'm OK as I wanted to hold the stock, I'll then look at the price of Call again and decide to write again or not.

I will 99% of the time select a strike price that is OTM and then chose an expiration date based on the return. I look to avoid writing a CC that extends into an earnings release period and consider dividend payment dates too.


I don't view CC as passive, I keep an eye on them going forward and use those data points to determine if I make any changes (close, roll or let it expire).

I always buy 125-150 shares of a stock. That way if I'm assigned, I'm still in the game if it keeps rising. My "keeper" stocks, I write about 30-45 days out, with a high strike. If I buy just a 100 shares, it's something I don't care about keeping. SPDR Etf's are good for this. I may do ATM strikes, but rarely. And I have stocks that I don't write on, MO,KMI,APAM, with 400-1500 shares each. Those are just for dividends. I like stocks with weekly as opposed to monthly calls. More opportunity. And I watch everything 2-3 times a day. I'm retired.

 

[JoshTrent]

You all have been very helpful - thank you!

I had 2 CC contracts expire 8/27 - both worthless. They were written at very high strikes, so I am not surprised. It was nice to collect the premiums (a whooping $63) though. I look forward to my options journey, and sharing experiences I garner along the way.

 

[bobandsherry]

You all have been very helpful - thank you!

I had 2 CC contracts expire 8/27 - both worthless. They were written at very high strikes, so I am not surprised. It was nice to collect the premiums (a whooping $63) though. I look forward to my options journey, and sharing experiences I garner along the way.

You don't call them "worthless", instead that they weren't assigned. If that was your goal/strategy then you were successful. While it's "only" $63, that's $63 more you have that you wouldn't and you still own the stock. Do that every week and it adds up and something you wouldn't have had otherwise.

When doing a CC, sometimes I do it for long term holds and squeak out a bit more $$ while continuing to hold the stock. So those I hope don't get called.

But some I get into for purely a trade/play with an expected decent return and OK with it being called/assigned, but if not still OK with holding the stock and lowering my cost basis for it.

 

[Sniggle]

Although I am a still a newbie at this option stuff, here is how I look at an option trade for other newbies:

- If I am selling cash covered PUTS, I look to capture around .5% in premium for the amount of cash required for the trade per week, and I look to set the strike price 2% or more below the current price. I also only write them on stocks I would be happy owning for a period.
- Earnings during the option period will affect option price quite significantly.
- I look at the chart to understand where the stock is over the last 12 months, what the lower resistance level is, and how the stock has reacted to events (earning, etc.).

- If I am writing cash covered call (or buy write calls) I look for an annual rate of return, if called, of more than 30% (premium + stock increase to strike price).
- Earnings and dividend can affect option pricing.
- You will be 'stuck' with the stock if the price decreases, or shoots to the moon, until the option expires, unless you buy to close the option.

- As you approach the option expiration, look for opportunities to roll it to a later date/strike. On Thursday before expiration Theta will start to fade, and by Friday noon theta will be effectively 0. Roll calls on days the stock is up, and roll puts on days the stock is down. I try to not give back more than 10% of the premium when I roll an option, and look to improve the strike price.

- Look at farther out expiration dates, but factor the extra time into your understanding of the potential gain from option contract. You will get more premium, but you will also have the money tied up longer.

- If the underlying stock drops on a covered call, you may need to ladder back up to your basis over several call contracts, and you could lose the stock (get assigned) before you reach break even. Some trades don't work out. On the other hand, if you are diligent you may over a few calls reduce the stock basis and be in the money well below the price you paid for the stock.

 

[jr6035]

You don't call them "worthless", instead that they weren't assigned. If that was your goal/strategy then you were successful. While it's "only" $63, that's $63 more you have that you wouldn't and you still own the stock. Do that every week and it adds up and something you wouldn't have had otherwise.

When doing a CC, sometimes I do it for long term holds and squeak out a bit more $$ while continuing to hold the stock. So those I hope don't get called.

But some I get into for purely a trade/play with an expected decent return and OK with it being called/assigned, but if not still OK with holding the stock and lowering my cost basis for it.

My strategy also. That $63 every month, plus hopefully the dividend every quarter, adds up nicely.

 

[jr6035]

Another way I do it, is wait for the dividend to be paid, then sell a CC that day for about 30 days out. That way I get paid the dividend and premium on the same day. It works well for my "keeper" dividend stocks, like APAM, O, MO.

 

[Sniggle]

Another way I do it, is wait for the dividend to be paid, then sell a CC that day for about 30 days out. That way I get paid the dividend and premium on the same day. It works well for my "keeper" dividend stocks, like APAM, O, MO.

That is a great idea. GS goes EXDIV tomorrow. I may do a buy write on 100 shares tomorrow.

 

[rayvt]

That $63 every month, plus hopefully the dividend every quarter, adds up nicely.

$63 is peanuts. Especially compared to the loss you will take when the stock goes down.

Oh, but I forgot----no problem, just sell the stock before it goes down. Easy-peasy.

CC newbies never learn. You collect $63 a month for 10 months, and then on the 11'th month you lose $2000.

The market is not in the habit of handing out free money.

 

[jr6035]

$63 is peanuts. Especially compared to the loss you will take when the stock goes down.

Oh, but I forgot----no problem, just sell the stock before it goes down. Easy-peasy.

CC newbies never learn. You collect $63 a month for 10 months, and then on the 11'th month you lose $2000.

The market is not in the habit of handing out free money.

Then I buy more. I on write calls on stocks I've had for years. You got a fool proof way?

 

[jr6035]

That is a great idea. GS goes EXDIV tomorrow. I may do a buy write on 100 shares tomorrow.

100 shares of Goldman is a lot of coin.

 

[NW-Bound]

Just to level set, I will say I'm not an expert on options, I've paid my "tuition" at the school of hard knocks along the way but started small so kept my "tuition" cost low. I learned a lot over the past couple of years on covered calls and consider I'm always learning. Compared to other option strategies, Covered Calls are low-risk.

You do make a good point, no one pays you a premium without risk. With a buyer and seller on each side of the transaction, one of you will be right, the other wrong.

However, I want to point out that I view your example is a single "play" in a series of downs and that may make up a longer-term game. I'd view there's game left.

Yes.

I just wanted to show that you don't win every time. It's the same as with owning stocks. Most people here believe that stocks win in the long run. It does not mean that your portfolio is going to go higher every week, or every month. It is not even guaranteed to go up every year. So, how do you expect writing call options will win every week, relative to the buy-and-holders?

All this is premised on holding stocks is good for you. If you do not believe in holding stocks, then you should not buy stocks just to write covered calls.

For "A", one would have to decide if "A" increase was short-term or not. If it was short-term, it may be possible to roll that to a longer expiration let the stock can settle back to $100. Or you could then let it get assigned and write a Put at $100, pocket a premium and wait for it to get back to $100. Or you get back in the game, rebuy the stock, write another CC (which could also cover your $100 "loss") and keep moving on with the stock. You might want to re-assess your strategy for setting a strike price. I look at strike price being set as what I might consider if I were to set a limit price, but then getting rewarded with a premium. So, I could make a point that the $100 "loss" isn't really a "loss" due to writing a covered call, but instead due to your own calculated exit price. Like how many of us haven't sold a stock and continue to see it go up in price?

Something else to consider is once stock price popped higher, you might look to sell a Put with same price and expiration as your Call. You pocket a premium for this which can soften that "loss".

For "B", similar decision point, is this drop short-term or not. If short-term it's possible to hold and write another option, pocket the premium and wait for the stock to recover your "loss". If you think this is a longer term drop then that would be your decision regardless if this were a covered call transaction, you still have the premium in your pocket. And as I had mentioned before, it's possible to ride the stock price down yet still pocket a premium that makes it profitable.

But to your point, a covered call doesn't allow you to be reckless. Don't just go for a high premium, the larger the premium, the higher the chance is you'll be assigned. Still need to do due diligence. Should continue to follow similar strategy that you use for your overall portfolio. For me, I typically avoid writing a CC that extends into an earnings release date. I also usually avoid calls for periods with dividends (or be sure to factor). I also only write CC on stocks I would want to continue to own.

The above are what I usually do. I will comment on these points later.

 

[jr6035]

I agree with everything here. Especially your last sentence. If I don't want to own it, I don't buy it. Although, I do veer from that, as I bought 100 shares of XLE, and wrote a call on it last week. It won't stay in my portfolio unless I like the premiums in a couple of weeks. I already own KMI, so I really don't need it.

 

[Sniggle]

That is a great idea. GS goes EXDIV tomorrow. I may do a buy write on 100 shares tomorrow.

I wanted to correct this, as my understanding of Ex Div was off. You need to own the shares the day before Ex Div to get the dividend payment. In the case of GS I already had a 300 stick position with a sold 410 call working, which was not called so I will get the dividend. But I could not buy more today and get the dividend.

 

[bobandsherry]

$63 is peanuts. Especially compared to the loss you will take when the stock goes down.

Oh, but I forgot----no problem, just sell the stock before it goes down. Easy-peasy.

CC newbies never learn. You collect $63 a month for 10 months, and then on the 11'th month you lose $2000.

The market is not in the habit of handing out free money.

Correct me if I'm wrong. But if the person were still holding the stock (since we are talking about a CC), they would still have seen a drop in the value of their stock value (and not a loss) of $2,000. Correct? So in your example, they collected $630 that offset a "loss" they would have encountered anyway.

A CC doesn't cause a "loss". Continuing to hold a stock that drops in value causes a loss. The fact that you had a CC doesn't make the loss more, quite the opposite.

 

[MRG]

$63 is peanuts. Especially compared to the loss you will take when the stock goes down.

Oh, but I forgot----no problem, just sell the stock before it goes down. Easy-peasy.

CC newbies never learn. You collect $63 a month for 10 months, and then on the 11'th month you lose $2000.

The market is not in the habit of handing out free money.

I'm writing CC on APPL I own with a $18 cost basis. What's the problem?

 

[bobandsherry]

I'm writing CC on APPL I own with a $18 cost basis. What's the problem?

I was curious what your stock was, thanks for mentioning it. This is a good example of making a little extra scratch while continuing to hold a stock you want to hold long. I don't recall if you mentioned what your duration was, but if it was a month, that's still $750/yr in your pocket.

At a $150/sh to value the return on the premium, that's still 5% you are paid while continuing to hold a stock what I'll assume you feel has continued upside. I guess you could see a $20/sh price drop in the next 10 months, but I'd also guess you'd keep on holding this so the premium helps to soften that possible outcome.

 

[NW-Bound]

A couple of fellow posters talked about how the premium from option selling can aid an otherwise money-losing position. Indeed, that is true. And one mentioned the stock MU (Micron Technology). I own this stock, and it's not one of my better positions, so I dug out my own records for an illustration.

On 1/1/2020, I owned 400 shares of MU, at the then price of $53.78. Now, I had gains on these MU shares that I bought prior to 1/1/2020, but I don't want to count the gain prior to 1/1/2020. I only want to show the effect of owning the shares since 1/1/2020, and selling options on them.

As of today, I hold 600 shares of MU, at the price of $73.70. If I had done nothing and just held the original 400 shares of MU until now, I would have an unrealized gain of 400*(73.70-53.78) = $6768.

Quicken shows that my net gain on MU is a mere $825 for the period of 1/1/2020 till now. How did this happen? How did the $6768 become $825? Well, I occasionally sold and bought back some MU shares from 1/1/2020 till now, as my options got assigned a few times. The most recent 200 shares that I had to buy due to puts getting assigned created a loss. The price of MU varied from $31 to $96, and I did buy high a few times due to the options. So, let's look over the records.

First, I need to say that because I sell options in a before-tax account, naked calls are not allowed. When a covered call becomes worthless near expiry, I still have to buy it back for pennies to "cover the call" before I can sell a new option on the same shares. If I were trading in a margin account, I would have no qualms carrying a naked call which is hopelessly underwater for a couple of days prior to expiry. But as it is, I have to spend a few dollars to buy the call back, even in a Friday afternoon before the call expires. Else, I cannot sell a new option until Monday.

Let's get back to the options on MU. I imported the downloaded records from my broker into a spreadsheet, did some sorting and here's what I compiled.

For 2020:
Premium from MU call options is $4291.64 minus $337.9 for call covering
Premium from MU put options is $2113.84 minus $157.2 for put covering

YTD 2021:
Premium from MU call options is $2239.04 minus $5.35 for call covering
Premium from MU put options is $974.76 minus $7.7 for put covering

The total cash from option transactions from 1/1/2020 till now is $9449.03. Add to that the $825 net gain from the shares, the gain is $10274.

That $10K is a bit better than the $6768 if I did nothing. Granted, the comparison is not straightforward because it included the 200 shares I acquired most recently, on top of the 400 original shares. However, it is these 200 shares that are in the red. Ignoring them would give a better result, but I cannot ignore them, because they are the result of the puts that I sold.

 

[NW-Bound]

My goal in selling calls and puts is to set the strike price sufficiently high so that they will expire worthless, but not so high that the premium is so little. And I manage that 85-90% of the time. What happens with the 10-15% of the cases?

Remember my example of writing a call at $102 to pocket $1 in premium, when the stock is at $100, and with expiry in 2 weeks. And in my example, the stock ends up at $105, and you sell the stock to have $103 instead of $105 if you did nothing.

Well, suppose that at the end of week 1, you see that the stock already climbs past your $102 strike price. There's even some good news about the sector the stock is in, and it looks like you are going to lose this stock to assignment. If you wait, the stock may head even higher, and buying it back is tougher. If the stock gets up to $105 in another week, and you want to sell a put to buy it back at $100, the premium is going to be $0.15. Perhaps you should act now.

So, when the stock gets past my call strike price of $102, I often sell a put for $100 to make a bit more money even though the stock does not look likely to drop back there. Or if I feel bullish on the stock, I would even sell a put at $102 for the following week, to get the stock back in case it pulls back.

The above tactic works quite often. But occasionally, the stock may climb up higher than $102 prior to the call expiry, but than drops back down and closes below it, say $101, at the call expiry. Boom, I still have the original stock, and now have another 100 shares bought at $102 because of the put.

That's roughly how I have 200 more shares of MU than I intended to hold, as narrated in my prior post. It happens.

 

[aja8888]

My goal in selling calls and puts is to set the strike price sufficiently high so that they will expire worthless, but not so high that the premium is so little. And I manage that 85-90% of the time. What happens with the 10-15% of the cases?

Remember my example of writing a call at $102 to pocket $1 in premium, when the stock is at $100, and with expiry in 2 weeks. And in my example, the stock ends up at $105, and you sell the stock to have $103 instead of $105 if you did nothing.

Well, suppose that at the end of week 1, you see that the stock already climbs past your $102 strike price. There's even some good news about the sector the stock is in, and it looks like you are going to lose this stock to assignment. If you wait, the stock may head even higher, and buying it back is tougher. If the stock gets up to $105 in another week, and you want to sell a put to buy it back at $100, the premium is going to be $0.15. Perhaps you should act now.

So, when the stock gets past my call strike price of $102, I often sell a put for $100 to make a bit more money even though the stock does not look likely to drop back there. Or if I feel bullish on the stock, I would even sell a put at $102 for the following week, to get the stock back in case it pulls back.

The above tactic works quite often. But occasionally, the stock may climb up higher than $102 prior to the call expiry, but than drops back down and closes below it,, say $101. Boom, I still have the original stock, and now have another 100 shares bought at $102 because of the put.

That's roughly how I have 200 more shares of MU than I intended to hold, as narrated in my prior post. It happens.

This sound like what I try to do.

If we only knew what the price of the stock was going to be at expiry, this game would be easier!

 

[NW-Bound]

This sound like what I try to do.

If we only knew what the price of the stock was going to be at expiry, this game would be easier!

Investing is a much more interesting activity than mere gambling, like some people think. There's no ending, unless you drive yourself bankrupt, or call it quit and take all your marbles to go home.

Things don't always work out as you plan, and you have to adapt. You have to think of what you have to do next, and most certainly how not to compound one problem by creating another.