HOW TO WRITE COVERED CALLS - A REAL CASE STUDY!
==================================================================
Date: Sunday, March 23, 1997 - Palm Sunday!
The stock: ROSS STORES (ROST) Last traded at $24 1/8 down another -2 on Fridays' close. For the week ROST is down $3 7/8. No surprise, some of you are saying, "hey what happen to that great stock that was a sure thing for $30 - $32.?" My reply, ROST is still a great stock and that the fundamentals are still there. I have to ask the question, why do people buy or invest in stocks? What do they hope to do? How much profit or income are they looking for and in what time frame? Some of you jumped on ROST late in the process and your starting to wonder if you made the right choice. Well, I'm going to review what investment tools have been used and what is going to happen next. Before that, let me give you the big picture.
Let The Trend Be Your Friend!
Let's put the emotions aside (greed & fear) and look at the clues on why ROST pulled back this past week after the actual split. First, the stock made a high during the week of Jan 10, 1997 of a range between $50.00 - $52 3/8. I used my data information charted on my SuperCharts (tm) by Omega Research. The above mentioned price range was ALSO ACOMPANIED BY HIGH VOLUME! It is safe to assume that $52 is the price resistance level for the pre-split price. The ROST stock price headed south (down)until it reached the $39 price range during the week of Feb. 07, 1997. Hence, we have a price range of high $52 - low $39 or a spread of $13 which is 25% movement.
After the 2-1 split the above mentioned reference points, the new high would be a range of $26.19 (high) - $19.50 (low). It should not come as a surprise that individuals that purchased the ROST stock back in January in $26.19 high range would be tempted to cash in the stock at the recent high of $28.00 for a min. profit as follows: $28.00 - $26.19 = $1.81 or 6.91% plus the div. paid out recently. So, the stock is still trading within "a normal rolling price range." Add to the fact the interest rate concerns by Greenspan and you saw the results. Fear started to take over this week. Knowing this, an astute covered call writer can and should prepare to still make money by applying some of the option tools out of the tool shed.
Don't Be a Putts, Buy Your PUTS!
First, I purchased the March 27 1/2 calls to milk the remaining upside move. I made a some profit of that. Paid around $400 and sold for $492.00 three days later. I have learned that "VOLUME PRECEDES PRICE!" Meaning? as a stock is making new highs and the volume tapers off, that is a good sign that the gravy train is coming to a stop and you better have your PUTS ticket ready. Always buy your PUTs as the stock is reaching a high to buy them cheap. USE YOUR CALL BUYER'S PREMIES!
What Covered CALL Cards am I Holding?
I'm still holding the covered calls for 4 April 25s Calls that is starting to quickly erode. In fact, my call buyer's April 25 Calls which sold for a total of $958 are only worth $274.80. That's $958-$274= $684 or 71.4% of the orginal CALL value. REMEMBER THE RULE: Cover your CALLS when you can KEEP AT LEAST 75%-80% of the original value! I knew I would beat out my call buyer. My original objective as a covered call writer is ONCE AGAIN becoming a reality! Another call buyer bites the dust! This week I will be looking to cover my calls and wait for the ROST price to start going up again! What am I looking for? More up volume, reversal in the Cash Flow indicator, and an oversold reading on the Bollinger Bands indicator.
Then PUT IT To Them!
My ROST downside protection of the 4 April 25 Puts started to appreciate this week. I paid $200 for the April 25 PUTS and they are worth $550 as of Friday. $550-200=$350 to add to my $686 (covered calls) + $94 sold calls. $686+94+350=$1,130(-$2.83 SO FAR). I sold the covered calls when ROST was at the $27 1/2 price. The price is lower now and is only worth $24 1/8. So, $27.5-$24.125 = -$3.375. If you compare the profit from the lower stock price you will find that the counter actions I have taken have worked very well so far. By that I mean that I STILL HAVE A LOWER NET COST BASIS! I may be able to close that gap even more if the PUTS become more valuable which I expect. Further, I will be selling another round of 4 covered calls for either the April or May contracts. Also, I will most likely buy a few calls on the side for leverage and profit booster.
SUMMARY:
Again, using my Excel template my net cost basis is down to a $19.88 NUT when you factor in the current trades and prices. At $24 1/8 I have a $1,696.05 ($4.24/share) potential profit or 21.32%. If called out (not likely) it would go up to $2,046.05 ($5.12/share) or 20.46%. The game is still in progress folks!
VIX Volatility
The VIX closed down on Friday by -1.87 at 23.88. Even my USRX starting to come back today. For the week, the VIX was up +.05 and next week should be interesting. Greenspan is expected to raise interest rates to cut off inflation. Inflation my foot. I guess I'll have to buy USRX PUTS now that expiration date is over and I'm still holding the stock. My repairs this week will once again put me in the plus column. I'm determined to make my call buyer pay for the trip down! I made one change to my chart for the VIX. I decided to raise the average level from 20 to 21 since the VIX index HAS NOT TRADED BELOW 20 since the new year 1997. So, I feel that 21 is calm waters nowadays and anything over 21 is ROCK AND ROLL! Remember, let the trend be your friend. May the FORCE BE WITH YOU like Luke Skywalker.
10 Year-T Bill
I can say it in two words. NOT GOOD! It closed at 6.73% +.05 for the week and you can see the results. HOLD ON TO YOUR HATS! LET ME SPELL IT OUT! It may be worth buying some puts for insurance. There is bound to be an initial knee jerk reaction this week. I don't know if the market has discounted prices for the expected raised rates. My plan is to cover my calls, time the selling of my PUTS. If prices go up I will buy calls, and then sell covered calls on the up swing! Here we go again.
That's It!
Wishing all of you, the BEST OF GOOD BUYS!
***********************************************************************************
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!
*********************************************************************************** |
