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Writing Covered Calls

Many financial advisors and more than a dozen websites advocate writing (selling) covered calls as a sound investment strategy. Thousands of subscribers pay millions of dollars to get advice on profitable covered calls to write.

I believe they are wasting their money. Writing covered calls only limits the potential gain you might enjoy.

Let’s take an example. You buy 100 shares of XYZ for $80 and write (sell) an at-the-money two-month call ($80 strike price) for $4.00. If the stock stays flat, you will earn 5% on your money for the period (plus collect a dividend if there is one). If you can do this six times a year (write a two-month call six times), you will earn 30% annually (less commissions); or so goes the promise.

(In the last chapter we showed that selling calls against a one-year option rather than stock results in a hypothetical 300% gain if the stock stays absolutely flat, or ten times the amount you could earn by writing calls against the stock.)

In this covered call-writing example, 30% is the maximum amount you can earn. No matter how high XYZ goes in price, you can never earn more than 30%. The bottom line truth is that you will NEVER earn that 30%. The reason is that no stock price ever stays the same. If the stock goes up by $5 in the first 60 days, you will either lose your stock (through exercise), or more likely, you will buy back the call you wrote, paying $5, and losing $1 on the call (but making $5 on the increase in the price of the stock). So for the first 60 days, you actually made a 5% net gain ($4 net gain on a $80 stock).

Presumably, you then sell another 60-day at-the-money call (now at the $85 strike) and collect perhaps $4.25. Then the stock falls back to $80. In this time period, you gain $4.25 from selling the call but you lose $5 in stock value for a net loss of $.75.

Your gains on the calls you wrote now total $3.25 for a 120-day period (you gained $4.00 in the first 60-day period and lost $.75 in hoped would earn you 30% for the year). At this rate (four months of activity), your annual return will be $9.75, or 12.2% on the original $80 stock. Commissions on six sales of calls over the year will considerably reduce this return — to 10% or so. Not a bad return, but certainly not 30%. And it’s an awful lot of work for a 10% return.

For a full explanation of an option strategy that is designed to outperform writing covered calls, check out Dr. Terry Allen’s Free Report on calendar spreads.

Terry's Tips Stock Options Trading Blog

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How to Play War Rumors

Last week, on Monday, there were rumors of a possible war with Russia. The market opened down by a good margin and presented an excellent opportunity to make a short-term gain. Today I would like to discuss how we did it at Terry’s Tips and how you can do it next time something like this comes along.

Terry

How to Play War Rumors

When the market opens up at a higher price than the previous day’s highest price or lower than the previous day’s lowest price, it is said to have a gap opening. Gap openings unusually occur when unusually good (or bad) news has occurred. Since there are two days over which such events might occur on weekends, most gap openings happen on Mondays.

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Making 36% – A Duffer's Guide to Breaking Par in the Market Every Year in Good Years and Bad

This book may not improve your golf game, but it might change your financial situation so that you will have more time for the greens and fairways (and sometimes the woods).

Learn why Dr. Allen believes that the 10K Strategy is less risky than owning stocks or mutual funds, and why it is especially appropriate for your IRA.

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