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Strategies & Market Trends : The Covered Calls for Dummies Thread
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To: FaultLine who started this subject6/8/2001 1:49:11 PM
From: FaultLine  Read Replies (1) of 5205
 
With Poet Trader's permission, I'm posting a discussion we've had over the last two days. Poet Trader sold covered calls this morning for the first time and joins us on the forum. Welcome Poet Trader.

--Ken/fl
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Yesterday PT wrote:
I was going to sell a jul70 or jul65 call on cien at premiums of 3.3 and 4.7 respectively with underlying stock at 61.50...if i got called out I would be thrilled, I think...and if not I've pocketed some nice change...I feel like I must be missing something because this seems too simple...and of course I know it isn't. thanks...PoetTrader
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To which I responded:
This looks great to me. Call me simpleminded, but it actually can be this easy IMO. Here's how I look at it (for the sake of calculations, let's just assume you buy the stock at the 62.50 and work from there):

I look at three things:

1. Return if called:
Add the stock run-up and the premium less the commissions. You've done that and it looks OK.

2. Return if unchanged:
Premium less commissions
You've done that and looks OK

3. What if the stock drops?
If you are already long then you'd be hit by that anyway and the cc premium mitigates the drop by the amount of the premium less commissions. If you are just now going long on CIEN then I presume you'd like to hold this stock in your portfolio anyway.

So you see, it really IS that easy. You are letting someone else use your money for a few weeks and for that consideration, they must pay you. You are willing to give up the possible homerun but you plan on getting a single or double every time at bat.

When you are willing to get called it all becomes very straightforward. Make the deal and pretty much forget about it until expiration day when you assess the results.
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To which PT replies today:
This morning after the precipitious drop in CIEN, bought 200 shares at 56.15 and sold two calls at Jul60 for 4.50. Because I have always been a parametric trader, it doesn't bother me at all if I'm called out -- I would be happy to take the premium, the profit on 60-56.15 (3.85 x2) and wait until the next drop.
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Summary (if held to expiration):
If called: 100(60-56.15) + 450 - ~50 = 785/contract (excellent!!!)

If unchanged 450 - ~50 = ~400/contract and stock held (this is good)

Downside breakeven: 56.15 - 4.50 = 53.65 or about a 7% downside cushion (not bad)

This is probably as good as any of us have regularly done. Nice move PT.

--dfl
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