DiB and Frank,
I don't know crapola about cc's, but I am proficient in using an HP12C. You're both wrong, which is the reason your debate could go on forever and neither one of you would convince the other that you're right, at least I hope you wouldn't be able to. :)
Seriously, both of you are trying to analyze a series of three transactions that is based on two investments but you're using a method that is intended for a series of two transactions based on one investment.
If we get totally accurate within the context that there is a time value to all money regardless of how little time there is between two transactions, you need to analyze the purchase of the stock and the writing of the call as two separate investments. That's justified by the fact that there are two separate risks being taken with the potential for two separate rewards. I realize that you're considering the purchase of the stock and the writing of the covered call to occur practically simultaneously (maybe even within a time span of only one minute), but an accurate financial analysis that computes the internal rate of return necessarily separates those two transactions.
The reason it's especially important to realize that is that in many cases you will buy a stock one day and write a call against it a day, weeks, months or years later. (Nah, no one around here holds a stock for years. :) When that happens, the only way you can properly analyze the return is to properly account for the number of days, weeks, months or years that take place in between the three transactions. That's easily done using a financial calculator or a spreadsheet and it involves a complicated formula that's far beyond what you're incorrectly trying to apply. In a spreadsheet, the formula is commonly labelled as the XIRR formula. (IRR is for internal rate of return. I don't have the foggiest idea what the X implies.)
Having said all that, I'll now reverse my self and tell you that you're both right. Based on the two different premises you are using, both of you are right. However, both of your premises are wrong.
Hope this helps.
--Mike Buckley |
