HOW TO WRITE COVERED CALLS - A REAL CASE STUDY!
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PAGE #9 Date: Saturday, Feb. 15, 1997
THE STOCK:Our case real case study is ROSS STORES (ROST).
At this point in time, we are waiting for the stock to actually split 2-1 and distribute the new shares. Also, we are waiting for the ex. div. date which will lock in our dividend. And finally, we are waiting for the upcoming earnings report and options expiration date for March. All the above mentioned events are going to take place starting in March. That makes this stock a very good case study because of:
a. the stock's fundamental qualities.
b. we get to see what happens when a stock splits.
c. we get to see what happens when a stock pays out dividends.
d. we get to see how we can make money using all those factors
in our favor as covered calls option cowboys (writers or sellers).
That is, we want to earn 10% to 25% rate of return per month (yes,
every month) writing covered calls!
So, allow me to finish up with yesterday's topic of the three indicators I use to base most of my call writing decisions. The three indicators are: 1. the 10-Year T-Bill Rate plotted with a 300-day moving average. 2. the stock's fundamentals (PE, EPS, news items, 20 & 50 day moving averages. 3. CBOE's Volatility Index (VIX).
It is the VIX that will give you the most information on a regular basis to out smart your call buyer. What I mean is, take advantage of the stock markets ups and downs, remove as much risk and make your call buyer pay for you "insurance."
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THE TREND IS YOUR FRIEND - MAKE VOLATILITY WORK FOR YOU IN COVERED CALL WRITING!
I was reading my IBD today and I an excellent ad caught my eyes for a booklet (for only $65.00) entitled: The Options Secret - Volatility! The ad correctly points out that professional traders know that NOTHING AFFECTS OPTIONS AS MUCH AS VOLATILITY and why the pros ALWAYS watch volatility when they trade options.
Your call buyers may not be paying attention to that important fact. If you read back some of the information I have tried to explain to you, you will notice that I advocate covering your calls (Dipity DO!) when ever there is a major price drop in the stock because I know that the call option I sold will lose value VERY FAST. If I can cover and KEEP 75% TO 80% of the call value premium I have in my account and turn around a few days after (WHEN THE VOLATILITY REVERSES) as the price recovers and sell another call AGAIN, I will make much more money within any month. Your gains will come from other people's losses!
So, repeat after me! Dipity DO - when the call price DIPS you will DO what? Cover when your calls (if you can get to keep 75% or more of the original value) and wait for a rebound in the stock prices. NOTE - If you sense a prolong downturn in prices, example: the stock is going from a 20-day moving average to a 50-day moving average because of price consolidation - base formation, etc. You can go out more than one month or lower the strike price of the call you are selling. Allways, know where you are with your NET COST BASIS! THIS IS THE DEFENSIVE STRATEGY PART THAT WADE COOK DOES NOT STRESS! If you do this all the time YOU WILL KEEP OUT OF DANGER OF HAVING THE STOCK PRICE DROP BELOW YOUR NET COST BASIS!
The stock prices will come back with time provided the fundamentals have not changed! Sometimes one, two, three days, or a week or so. It depends on the stock. I'm still an owner of US Robotics shares right now. And, I have NEVER BEEN IN A MORE ROCK AND ROLL, UP AND DOWN STOCK LIKE THIS BABY! What I have really really really learned is the value of Dipity DO to still make a little money. The point is, I'm NOT LOSING MY MONEY! I'm waiting for the explosion in price when USRX finally gets that 56K modem out on the market and selling and the price skyrockets. I'm cashing in my chips bigtime as the crowd rushes in!
The VIX gives you an advance warning of turburlance ahead. I'm mentally looking for the right time to execute my strategy. As the price drops and PEOPLE RUN FOR THE HILLS THEY WILL DUMP THEIR STOCKS! Down goes the value of those calls, and I'm covering by bets. At that point, guys like STEVE are cashing in ALL THOSE PUTS and eventually there will be MORE BUYERS THAN SELLERS AND THE STOCK PRICE HAS TO (bounce) GO UP!
This action is repeated OVER, and OVER, and OVER again! And, people are making money all the time. In fact, I truly believe that there is more money to be made by covered call writing and playing the rolling stock pattern than trying to find the next Netscape, Diana, Iomega when the price is increasing three-fold! Most people those know enough to find the mother load, but cover call writing anyone can do very successfully once you understand the dynamics!
In my local newspaper today, there was an article entitled: "Market's extreme single-day swings have experts guessing". In it, one statement was, "This volatility, which extends back to last summer, flies in the face of some expectations."
"When you see spikes in volatility, generally, people believe it is associated with market declines," said Joseph Levin, vice president of research and product development at the Chicago Board Options Exchange, where he oversees one of the best measures of volatility, the CBOE Volatility Index (VIX). "But volatility," Levin said, "does not indicate direction." This is exactly why it works for me and many others traderS and now you readers! You see, the masses follow the herd that are ALL reacting to the volatility. THE SKY IS FALLING, HELP ME, I'M FALLING AND I CAN'T GET UP CROWD! The fundamentals have not changed, the interest rates are stable, inflation is neutral, etc. Simply put, in percentage terms the intra-day moves may not be so remarkable. "At 7,000 points, 50 points on the DOW Average is a move of less than three-quarters of a percent". The market is volatile by nature. If stock prices didn't change, equities would return ZERO, and a passbook account would be a better investment.
In closing, the CBOEs volatility index (VIX) has risen sharply in 1997. The VIX Index, which the exchange launched in 1993 to measure implied volatilities of option contracts that trade off the Standards & Poors 100 stock index, currently measures reading as high as 22.5. Over the course of the past two years the DOW industrial average topped 6,000 for the first time, the VIX reading was 15.5. So it's risen 45.2 percent in less than six months. At the same time, same-day swings in the market have become more pronounced, catching the attention of the market professionals. And, this year is off to an even crazier start.
Folks, another way to extract profits from the stock markets is for market makers to WIPE SAW buyers and sellers out of their positions! They make money on the way up and on the way down! You know that they DON'T WANT TO BLOW UP THE FREE MARKETS! They just want to RIP YOU OFF IN THIS REAL GAME!
It's time you become the options sledge hammer for once and not the bent nail call buyer! Become a covered call writing cowboy!
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DISCLAIMER: The writer is presenting a real stock and a live ongoing case study. No recommendations or endorsement to actually buy this stock are suggested nor implied. Trading stocks and buying calls should not be attempted without first understanding the risk/rewards of this type of investment!
The writer assumes no responsibility for the opinions being expressed!
Buyers always be aware!
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