JohnM
I considered writing 4 contracts on Qcom at 50 (a portion of our holdings), with a strike price of 55. I don't now recall what the premium was at the time.
Last time QCOm was at 50, the JUL55 call traded at $2.00
2. Buy back the calls. I would be able to keep the shares and, thus, the price runup. But, would obviously lose the difference between the sell and the buy back price of the premiums. I guess they (price runup and premium loss) would, roughly, cancel out one another. This scenario leaves me with no loss and no gain.
You would still have a gain. If the stock closes at $70, the JUL55 call will be worth $15 at expiration- no time value remaining- all intrinsic value. To buy it back you will likely have to pay some spread, so it would cost you maybe $15.20. Your effective cost of owning the stock will then be 50 - 2 + 15.2 = $63.20. This is essentially the same as if you let the stock get called away. Either way, you have made a nice profit on your trade (realized if you get called; unrealized if you buy it back and book the loss on the call), most of which came from the stock rising- not nearly as nice as if you had not sold the call. The decision between these two alternatives would depend on your view of the stock going forward. If you think the stock is overbought and will likely pull back then let it get called away. If you think it has room to run, then maybe you want to hold on to the stock, or maybe let half get called away and keep half.
3. Roll the call up. When I buy back the options, I write a new call for the following month that, again roughly, covers the buyback loss plus, hopefully, some additional premium gain. I, most likely, lose the premium from the first month but am alive with the shares and hopes of a premium payoff in the following month.
You do not lose the premium from the first month. That $2 you collected was all time premium, and now the time has expired so it is yours to keep. What you have lost is opportunity- the $15 difference between the stock price and the strike price. The only question as you consider this alternative is which strike and month do you want to write going forward. You are basically back where you were before buying at 50 and writing the JUL55, except that QCOM is now a $70 stock that just made a nice upside move instead of a $50 stock that found support after an extended sell off. That's a big difference!
Some people advocate writing ITM calls on stocks that have run up figuring they are more likely to retreat than move higher. I may be a minority voice on this, but I consider that a poor choice, unless you have a situation where you must hold the stock for tax or some other reasons (selling too far ITM makes you liable for taxes anyway, so that is rarely a good reason to hold the stock) The name of the game in CC writing is collecting TIME premium. Collecting intrinsic value, as you do when you sell ITM, is just taking some of your money out of the position, and there are better ways to do that- namely sell some stock.
Oh, yes, this is clearly one reason Frank is right about his preference for short month writing. Were I to write Qcom ccs a couple of months out and waited until the last week or so to make decisions of this sort, I would run the very real risk of a much higher price than 70.
Well... maybe. Short month writing does give the best initial time premium per unit time, but the premiums are small and offer little downside protection. They require a lot more attention. If you were looking to buy/write QCOM as I write this, the price on the stock is $52.80 and the strike 55 calls are bid JUL 2.45, AUG 4.60, OCT 7.90. Those give substantially different net investment costs (stock price - premium). Plus, the premium will fall faster as well as farther for the out months if QCOM pulls back. And if the stock does run higher fast the outer months will bleed more time premium than the close month, and still have more to give while the close month has capped all future gains. This puts you in a better position for rolling up or out. If you look at the prices on the 35 strike calls (roughly $18 ITM) you will see that it would now only cost $2.20 more to buy back the OCT compared to the JUL, while the difference in premium collected on slightly OTM calls is over $5. If you project that difference onto your run to 70 scenario, you can see that at the end of the first month you are $3 to the better for having written outer month calls with higher premium. Writing close month calls is better if the stock makes a nice steady climb and you repeatedly capture premium w/o ever having to pay up for a stock you want to own or lose money on the calls. It is not better for stocks that make wide excursions.
Finally, since it is just this sort of wide excursion you are afraid of with QCOM ask yourself if $2 of time premium while limiting your potential gain to $5 (on the stock itself) is worth collecting on a stock that you think might move $20 on you before the option expires, and does it offer enough protection if the stock happens to make that excursion in the wrong direction? Is there a chance QCOM will fall to $40 before expiration putting you $8 in the hole? If you really think either of those things can happen you should compare writing CCs as you described to what would happen if you just held half as many shares of the stock. What you will find is that you are better off with a half position than with CCs if the stock moves hard either way. CCs are better only if the range of movement of the stock is a small multiple of the time premium you can collect. Ten times is really pushing it.
Your concerns are well founded. Good luck with whatever you decide to do.
Dan |
