Writing covered calls

[whitestick]

I hope so.

A poster at http://answers.google.com/answers/threadview?id=563829 said they couldn't find anyone unhappy with the method. Makes me wonder if you have to sign statements saying you won't complain in public.
Of course not. Even if someone tried to do that, wouldn't the anonymity of the Internet allow someone to legitimately complain. The only ones that I ever hear complaining are the ones that haven't taken her course. They have the prescience of being able to say what is wrong with her method, without having knowledge of the facts.
Or, maybe everyone's still happy because the market is up, and they haven't yet noticed the problem of unrealized losses.

 

[whitestick]

RE: 'yield' calculation

I don't see how you can say that some number on your worksheet ('allocated dollars') is 'hard cash'? The account balance is hard cash - no other number is or can be 'hard cash'. ...

And, if you are saying that your 'allocated dollars' is a number that is less than the account balance ( I think this is covered in the patent app, I'd need to look again - but it makes sense - allocate some portion of your account to these stocks, leave some in reserve) - well if you are using a smaller number in the denominator of your yield calculation, that makes your yield number look even higher (better) than it really is. So, it appears that my 'yield' calculation is more conservative than the one you use. I base the yield calculation on the starting balance of the account - the amount I put in. Pretty basic - equivalent to the 'coupon' rate of a bond. Again, total return (including the NAV of the bond in this comparison) is a different number.

As you said, and explained in the patent app, the allocation is the money initially planned to be invested, IF the fully amount is purchased over the time anticipated if the worst case happens. Thus even though you haven't used that money (and it is still receiving interest income invested in MM until used by the broker), the yield calculation is based on that total amount. If the close occurs early in the cycle, the total dollars are higher then the account balance. If later, and the account balance has increased due to the underlying stock increasing in value at the end (prior to closing due to being higher then the average cost of your underlying stock), then potentially the account balance could be higher. It appears that your calculation is only based on the value of the stock that you have actually purchased, which if ITM as I believe you said you do, then that would be a very short term of holding your cash in the underlying stock. And would not reflect the available cash allocated but unspent. This method seems to be a much more conservative approch then your assumption.
Fine, just keep doing that. But if your yield number is greater than the 'total return' number, as it was in my example, (that you want to ignore), and you keep tapping off your yield, your account balance *will* dwindle. It is basic math - nothing can change that. It might dwindle slowly in an up market, or even rise, but I am afraid that you can expect a basket of volatile stocks to dwindle quickly in a down market. Eventually, that chicken comes home to roost. You can't keep drawing a yield greater than the total return (no matter how 'consistent' that yield is), and not end up broke - that is why I am telling you that the total return number is important, and a basic measurement of any financial investment.
I don't believe that I ever said that the account value would not be increasing as you make your trades and reinvest the options income each month. Of course it will. The issue I have been addressing is that the money you withdraw to live on, reflected by the cash flow or yield, is of concern, as you want that to be as consistent and repeatable as your monthly bills are. I attempted to state many times that the measurement of "total return" based on the capital appreciation of the underlying stock is the part that is considered irrelevant, as you are generating the monthly cash flow, that you want to withdraw to live on. To me (this is my simple analogy), it is akin to purchasing an annuity. Forgetting the bad things about an annuity for the moment. With the purchased annuity, you are interested in the monthly check that you receive, not the underlying capital balance that the insurance company is using to produce that check. As the underlying balance ebbs and flows, the insurance company continues to make the same payment to you. Of course this analogy breaks down in that in the annuity, you don't get your capital back, while in this method you do. And if your budgeted withdrawels permit some of that cash generated each month to be reinvested, then your account balance will increase. But that increase is based on the income from the option premium, not the increase in capital value of the stock. Should the account balance decrease due to the lowering of the underlying portion of the stock price, you are still putting (in this case) additional money into the account. When the position is closed at a price higher then your aveage cost (at that point in time) you "swap" the stock for cash. You still have the uninvested portion of the allocated money that remains in your account, even though you may have not used it up in purchasing the underlying stocks. It is for that reason that I track yield of each position, and not overall "total return", as it becomes difficult to normalize every position relative to each other. That is more then I wanted to say, but patent app gives you most of that, albeit in different words. If this is too oversimplified then I appologize, but some of the other writers comments, seemed to indicate that they weren't interpreting our discussion this way.
If your total return is not consistently positive, or at least as positive as the market or a bond fund or whatever investment you want to benchmark it to - then you should be in the benchmark. It is just that simple. You cannot ignore total return, unless you want to lull yourself into complacency, and potential bankruptcy.

-ERD50

 

[whitestick]

I didn't look at the discussion as a debate over right or wrong....... but rather two ways of quantifying results. By the time you guys went back and forth several times, I think I get it , especially in the example where you showed your actual results based on total return vs yield.

Thank you, that's the way I was interpeting this as well

 

[whitestick]

Yep. That's what we've generally done, but since no one responded to youbet's suggestion, I thought I'd try to get some input.

I've enjoyed the discussion, but you may be right. We may be getting close to dead horse beating

 

[ERD50]

We may be getting close to dead horse beating

Close? Close? Close?- that horse and the stick he was beat with was a pile of dust 3 pages back.

I'm not sure if I should respond to anything at all in your recent posts, or just let them stand as a monument to delusional thinking. I'll keep it short -

the measurement of "total return" based on the capital appreciation of the underlying stock is the part that is considered irrelevant,

Yes, you keep saying that, and that is one of the most dangerous statements made by an investor I've ever heard - I thought you were just confused about this, but you really believe it, don't you? That is too bad.

Annuities and bonds have a completely different risk profile than stocks. IMO, anyone who does not understand the risk of holding a basket of volatile stocks, shouldn't.

Good luck to you -ERD50

 

[ERD50]

[satire]

Oh, wait a minute, I just had a revelation! I take it ALL BACK! You ARE right whitestick! Total return does not matter!

You see, all those people who held the QQQQ from Early 2000 until now, and thought they were in trouble because their investment shrank from 110 to 40 over the past six years - well, they can just start dancing in the streets! They didn't lose money like they thought, they actually earned a small dividend! They are UP! Their investment is safe!

Oh, I'm sure they feel much better, after being enlightened that 'total returns don't matter'.

[/satire]

Unbelievable - ERD50

 

[bosco]

This thread could not possibly reach the "Best of" category. Best of what? Best example of persistent and tediously explained delusions?

Ha

couldn't have said it better myself.

I vote NO!! Definitely does not belong in "Best of" Is there a category for "most obsessive and repetitive?"

Problem is, it falls well short of h0comania in terms of persistance, but ....keep trying

 

[Texas Proud]

OK... just for fun....

Let's say we have a big up market.... and ALL your stock is called...every last share... and the market went up 10%... but you sold out at a 1 or 3% gain because of calls....

NOW, to write more covered calls, you must buy some stock... but wait, it is MORE expensive.. but who cares, total return does not matter at all...

I am not saying that if you have in your head to sell a stock at a certain price that writing a call is not a way to boost your return. If the stock sells, you are happy because you WANTED to sell at that price. If you write a call on a stock you would not want to sell, you are being stupid.. (could not think of a PC word... so) stupid (it is)....

 

[whitestick]

OK... just for fun....

Let's say we have a big up market.... and ALL your stock is called...every last share... and the market went up 10%... but you sold out at a 1 or 3% gain because of calls....

NOW, to write more covered calls, you must buy some stock... but wait, it is MORE expensive.. but who cares, total return does not matter at all...

I am not saying that if you have in your head to sell a stock at a certain price that writing a call is not a way to boost your return. If the stock sells, you are happy because you WANTED to sell at that price. If you write a call on a stock you would not want to sell, you are being stupid.. (could not think of a PC word... so) stupid (it is)....

I like fun!
Ok, in your example, you are relating to the capital side of the equation, and forgetting about the income side. The option premium (income) is the part that returns to you the 13+%, and the stock which has now been called away and must be repuchased (in this limited example) would indeed be purchased at the higher price, and a call sold against that higher price for additional premium. In reality, the entire market doesn't go up uniformily, and the stocks that are called away are replaced by other stocks that have better premiums. Other stocks may have stayed the same or gone down during this same short period. By applying the filter criteria, looking for stocks meeting the requirements you are looking for, you will likely purchase different stocks in this case. In many cases, you are looking for stocks that have gone down in this market you just described, as they will likely be optioned at higher premium, with the expectations that they will rise either with, or contrary to, that rising market. Similar to the reason for diversification into other classes of stock/funds that have been discussed on many other threads here. When following the method for short term options, you are more interested in the volatility of the stock, rather then the relative stability. Longer term options (6,8 12 months out) have a different criteria.
And to be perfectly clear, I NEVER said that "total return doesn't matter at all", but rather the measurement of total return, as defined by ERD50, is irrelevant. If a+b+c=d (total return), and you are measuring a, and measuring b, and measuring c, then the "measurement" of d is irrelevant. I'm tracking the a,b,c items, in this analogy on different time tracks, and concerned about different things. Or to restate - the increase in return value comes from the income of the option premium, not the increase in capital valuation of the underlying stock. And the benefit is a stable cash flow to match your expenses. Which was my goal, to have for retirement, when the bills come in each month. That's why I think we are closer in agreement then is apparent, it's just the words that are getting in the way.

 

[ERD50]

This thread could not possibly reach the "Best of" category. Best of what? Best example of persistent and tediously explained delusions?

Ha

couldn't have said it better myself.

I vote NO!! Definitely does not belong in "Best of" Is there a category for "most obsessive and repetitive?" ...

Well, as one of the persistent, tedious, obsessive, and repetitive posters on this thread, I agree. I vote NO also.

I think there is some valuable info in this thread, but there is far too much back-and-forth over convoluted explanations and defenses of yield, risk, and 'total return' to wade through. It's painful.

If covered call strategies and the seminar sellers of 'low-risk' strategies could be summed up neatly, I think it would be a nice addition to the forum, as a reference for people that are considering forking over $$$$ for 'secret info':

1) Covered Calls (or selling puts) provide a premium, you can think of it as a monthly dividend, or 'income stream'.

2) Selling calls/puts limits your up-side. You are likely to underperform when the market is 'hot'.

3) When you sell calls/puts, you are subject to all the risk of holding the underlying stock, offset only by the relatively small premium. 'Safe' stocks generally will not pay enough premium to make this strategy attractive. Do not underestimate the risks.

4) The people selling $$$$ workshops, downplay the risks, and do not measure 'total return'. They don't provide performance data that can be compared to other investments. One does not provide performance data for the down market of 2000-2002, but does provide a 'yield' number for the up market of Sept 2002 to present.

Google: compoundstockearnings and: kimsnider.com for examples ( I am not providing direct links - there is some legal wording about that on one site at least)

5) It is unclear what reporting standards the seminar publishers are held to - apparently not the same 'total return' reporting standards as Mutual Funds (bonds or market index), or ETFs, which would likely be our benchmark.

6) If 'secret' methods of stock selection, and 'averaging down' were effective at reducing downside risk- wouldn't other bright people be employing these techniques to advantage?

I think those statements are rather complete and unbiased.

Now, for my OPINION: either # 4 or #5 by itself would be recognized as a huge, waving, bright, neon red flag to the knowledgeable investor, and are used to distract the less knowledgeable investors from the real risks. #3 and #6 are yellow flags, not to be underestimated, especially by the inexperienced investor.

How many 'low-risk, high-gain' seminars, systems and books have been presented over the years? How many are still around? How many people on this forum achieved FIRE'd status because they used a purchased 'low-risk, high-gain' system through a down market? How many FIRE'd people on this forum trust that one can ignore 'total returns'? But, this time it's different?

I think I'm done (I sure hope so). Thanks to all who contributed, and I would like to follow up on the discussion of risk vs reward (in general) with lazyday - on another thread?

-ERD50

References - Try googling the following to glean info about 'total return' from these workshops:

site:compoundstockearnings.com "total return"

site:kimsnider.com "total return"

more recc reading:

"Fooled by Randomness" by Nassim Nichales Taleb

"Against the Gods: The Remarkable Story of Risk" by Peter L. Bernstein

more good references to earning 'income' while losing money here (must join group to view): http://finance.groups.yahoo.com/group/compoundstockearnings/

a sample conversation was someone bragging that they made $5400 on $80K in their first month, then coming back to admit that they actually lost $4000 when they consider their positions in the red.

 

[ERD50]

ohhhhhhh my,

the measurement of total return, as defined by ERD50, is irrelevant.

Sorry, whitestick, it's not MY definition, it is THE definition:

About.com Investing for Beginners

Calculating Total Return and Compound Annual Growth Rate (CAGR)
To effectively evaluate your investment performance, you will need to learn to calculate the return or loss for each of your positions (e.g., stocks, bonds, mutual funds, gold, real estate, car washes, etc.) There are two important equations that can reveal this information; they are total return and compound annual rate of return.

Total Return
The total return on investment is straightforward and easy. Basically, it tells the investor the percentage gain or loss on an asset based upon his purchase price. To calculate total return, divide the selling value of the position plus any dividends received by its total cost.

since, in my example:

Remember: (End_Balance minus Start_balance) divided by Start_Balance

the premiums are deposited in that same account, so they ARE included in the calculation. And, when you 'mark everything to market' each period (take the liquidation value at the begin and end period), you are referencing your cost at that point in time. Simple.

And to be perfectly clear, I NEVER said that "total return doesn't matter at all",

Ummm, then what are you saying about total return - I thought it was clear - I guess not?

I attempted to state many times that the measurement of "total return" based on the capital appreciation of the underlying stock is the part that is considered irrelevant,

Is it that ''based on the capital appreciation of the underlying stock' phrase that exempts you? Hmm, I never said to calculate all that, just follow the standard definition of 'total return' - it encompasses everything in one, easy, non-weasel calculation.

I'm tracking the a,b,c items, in this analogy on different time tracks,

Wow, I'm sure there are some bond fund managers that would like to be able to do that - they could apply their high interest dividend years against their low NAV years, and come out looking like a much lower volatility investment than they really are. Good thing we have the SEC behind us on this. I like consistent, honest, non-weasel, apples-apples reporting of performance.

You might want to stop feeding me ammunition now.

-ERD50

 

[Nords]

couldn't have said it better myself.

I vote NO!! Definitely does not belong in "Best of" Is there a category for "most obsessive and repetitive?" ...

Well, as one of the persistent, tedious, obsessive, and repetitive posters on this thread, I agree. I vote NO also.

I think there is some valuable info in this thread, but there is far too much back-and-forth over convoluted explanations and defenses of yield, risk, and 'total return' to wade through. It's painful.

Trying to flatter the judges won't succeed!

It's not about the posters or their writing styles. It's about whether a topic has been thoroughly covered and can be easily located for future reference. Can you guys imagine doing this all over again in a few months with a fresh crop of newbies?

 

[brewer12345]

Can you guys imagine doing this all over again in a few months with a fresh crop of newbies?

Hard to imagine a fresh batch of people as truly clueless/self-delusional as whitestick showing up every few months. Is Kiyosaki really that popular?

 

[Nords]

Hard to imagine a fresh batch of people as truly clueless/self-delusional as whitestick showing up every few months. Is Kiyosaki really that popular?

How do you think we became moderators?!?

 

[brewer12345]

How do you think we became moderators?!?

By being in the bathroom when Dory asked for nominations?

 

[lazyday]

I would like to follow up on the discussion of risk vs reward (in general) with lazyday - on another thread?

Sure, here or new thread.

(Hopefully I'll catch it; I don't read every thread here, and don't visit every day. Just bug me if I don't reply. )

 

[whitestick]

Ummm, then what are you saying about total return - I thought it was clear - I guess not?
After the many pages of dialogue, apparently not

Is it that ''based on the capital appreciation of the underlying stock' phrase that exempts you? Hmm, I never said to calculate all that, just follow the standard definition of 'total return' - it encompasses everything in one, easy, non-weasel calculation.
2005 69.3548%
2006 60.9524%

You might want to stop feeding me ammunition now.
Why stop, when it's so much fun?
-ERD50

 

[ERD50]

Trying to flatter the judges won't succeed!

Oh, I was that transparent? - You guys/gals are good (oops, there I go again).

It's not about the posters or their writing styles. It's about whether a topic has been thoroughly covered and can be easily located for future reference. Can you guys imagine doing this all over again in a few months with a fresh crop of newbies?

Ok, I see your point. In that case, yea - refer any new can't-lose-covered-call-cultists to this thread. Tell them not to invest a penny until they read every word - that oughta keep them safe for a while.

-ERD50

 

[ERD50]

2005 69.3548%
2006 60.9524%

Wow, with 'total returns' like that, you sure gotta wonder why Kim does not post 'total returns' on her website. Especially now that everything meets 'regulatory requirements'.

She would look like a financial goddess! Seriously, she should open a mutual fund - she could charge 10% fees for that kind of performance, and make 10% on the billions that would flow in.

I'm sure there is a good reason , but I also imagine it could not be explained in 500 words or less.

At the minimum, it sure would attract more people to her seminar. Yet, she does not publish them. What to make of that?

-ERD50

 

[whitestick]

Wow, with 'total returns' like that,

Based on mine, not Kim's, and as I believe that I said before, I am a bit more aggressive then she is. For one thing, I make heavier use of margin then she does. I am reducing some of that use of margin, back to zero, or very close, so my numbers will likely get more in line with hers.
Been interesting discussion, think I'll move on to other topics now.

 

[ERD50]

heavier use of margin

whitestick, you are using margin in this strategy ?? ?? !! !! !!

Margin amplifies the impact of the downside risks that you choose to ignore. Take all my warnings, and multiply them by that leverage factor.

Using margin while holding a basket of volatile stocks can wipe out an account faster than you can say 'where did I put Kim's phone number?'

You are playing with fire. Fire and gasoline. Lotsa fun in an up market. Enjoy it while it lasts.

-ERD50

 

[lazyday]

Not sure how well researched this is, but here's an article on covered call funds.

http://www.onwallstreet.com/article.cfm?articleid=3489&pg=ros&print=yes

Since fall 2004, more than 30 buy-write funds that have amassed a total of about $20 billion in assets have been rolled out.

Fund companies started with the basic idea of buying a portfolio of diversified stocks and hedging it with options. Over the last year-and-a-half, the model has been tweaked to buy indices, as well as individual stocks, and write calls on both.

 

[whitestick]

Such so-called "buy-write" funds boast yields of about 8% to 9%, with some as high as 10%.

but...but...but... what's the "total return" signed ERD50 : : :
Thought I'd save him the trouble

 

[lazyday]

Well, that article was written for financial advisors, and read almost like a sales pitch.

Just posted it for the quotes in my post above, on the magnitude of these new sellers of covered calls, and the notion that they felt compelled to switch from buy-write on individual stocks, to also use indexes. (Maybe not enough liquidity for all the covered call selling on individual stocks? Or maybe just to keep expenses down.)

 

[ERD50]

but...but...but... what's the "total return" signed ERD50 : : :
Thought I'd save him the trouble

No trouble at all. And, I guess I don't get the 'joke'? All mutual funds present total returns per SEC guidelines - unlike Kim Snider or compoundstockearnings. And mutual funds don't get to pick the time frame either. It is publicly available information. What's funny about that?

I've mentioned BXM before, here's one that was mentioned in the article (ETV):

http://www.eatonvance.com/alexandria/2412.pdf

1 Year Total Return 9.70%

Since Inception Average Annual Total Return 11.67%

They yield about 11% on the original investment ($.475/Q), share price is up about 1.6%, but has been down also.

Any fund you might want to invest in has that info for the looking. Here is a study on BXM : http://www.cboe.com/micro/bxm/IbbotsonAug30final.pdf

Now, what would be enlightening (and maybe funny) is to see Kim's 'total returns since inception', including the down years of 2000-20002. Oh, but she just 'can't share that info', can she? Now that I find 'funny', but not 'funny like a clown' funny.

-ERD50