Thread - Conservative CC Strategy:
I've been working on (and practicing) a conservative cc strategy for beginners, like myself. Here's the plan <scheme>:
1) Buy a "value" beaten-down stock. Stock must be good quality with good growth and just temp. out of favor, down due to over-reaction, etc. THIS IS THE HARDEST PART OF MY STATEGY. I use several components of FA to determine this - PEG, P/B, P/S, PE relative to industry, low debt, lots of cash, etc. - THE BASICS. fool.com is very helpful as are various SI threads on value investing:
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2) Of course, stock has to be optionable, with enough volume in the options and several strike prices to choose from on both sides of the stock's current price one to two months out. For example, if stock is down acutely due to bad news, sometimes there is no strike price below the current stock price. This keeps you from being able to sell an in the money call or roll down (if need be).
3) Best if stock has fairly high historic volatility (.4 to .7) I get this figure from etrade option analysis. Usually, I've found that when a stock falls quickly, the implied volatility goes up and the options are more expensive. Thus, a juicier cc to write. McMillan's newer options book "McMillan On Options" (The sequal I believe is entitled "McMillan On Dope" but don't quote me on this <ggg>.) has a sections on how options can predict movements of stock price. One is that after/during a rapid fall in price, when the implied volatility goes way up it MAY predict a reversal in the downward trend in stock price.
4) "Don't try to catch a falling knife." If a stock is dropping rapidly, wait and see if it bottoms and levels off. TA can help with this.
5) I try to avoid earnings if I can. I'm too chicken and not experienced enough yet to predict earnings and weather a big price drop. An exception is after a negative pre-announcement with BIG price drop and you think the actual announcement will have little to no affect on the stock. Of course, there are plenty of other things that can drastically affect stock price besides earnings, but these are actually planned so I can know when they are. If you must hold a stock through earnings, I buy protective deep out of the money puts ala steve.
6) Ok you bought the good solid growth stock that is temporaily out of favor or overly beaten down for short term reasons and has no potentially neg suprise earnings around the corner. THESE ARE ALL THINGS TO LIMIT THE DOWNSIDE POTENTIAL. McMillan points out that covered call writing has more downside protection than just plain ole stock ownership, BUT LIMITED UPSIDE POTENTIAL. Therefore we need to minimize loses b/c they are hard to make up with limited upside.
7) Now pick an at the money/ slightly in the money call to sell one to two months out. If you have good info that makes you think there is high probability of quick updraft, maybe write an out of the money call at the next strike price up from the current stock price. I CURRENTLY SELL THE CALL AS SOON AS I BUY THE STOCK. Again, I am chicken and am always afraid that the stock will go south as soon as I buy it. Why not lock in profit from that inflated cc imediately?
8) Watch and hands off! This is a beginners strategy. I'm not yet ready or good enough to figure when the dip is to buy back my cc and when the high is to sell another cc. you only have to wait 1-2 months at most anyway. you can always paper trade when you would buy/sell those cc's and if you get it down where yoiu make more $$ that way then GO FOR IT!
This strategy thusfar (2-3 mo's) has worked with most if not all (too soon to say) of the 10 or so stocks I have done it with. With 40-50% margin, i shoot for a monthly return of 10-20%. given mistakes, price drops, etc. if i can average 6% a month that is compounded and annualized to 100% a yer - doubling my money. Heck, if I can average 43% a year, that is doubling my money every 2 years (not counting taxes! Works better in an IRA) And this is a "conservative" cc strategy - selling at or in the money calls. We'll see if i can achieve it or not.
Comments, corrections and constructive criticism are more than welcome.
This is currently working for me with ATML, INTC, PERI, MLR, AGP, COMS, IOM, and, yes, VVUS. Just bought APM for 30 and sold the Nov 30 call for 3. (Yea I know they've got earnings this month - what the heck! I may get some cheap pp's)
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