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Strategies & Market Trends : The Covered Calls for Dummies Thread
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To: Dr. Id who wrote (20)4/19/2001 10:25:13 AM
From: BDR  Read Replies (1) of 5205
 
<< my covered call writing prior to today made me feel like a master>>

That's right. The past six months have made call writing look easy.

Step 1: Write front month out of the money call on the tech stock of your choice.
Step 2: Watch said stock drop 20% in value in a month.
Step 3: Wait for call to expire worthless and collect 100% of the premium.
Step 4: Repeat Step 1.

Pure genius.(g)

Now we have to actually deal with the possibility of the call being exercised. Suddenly we don't feel so smart anymore. The ever so smart short sellers that have shown up to harangue us on certain threads lately must be experiencing something of the same feeling.

Seriously, when I get in this position it helps me to go back and review the circumstances that existed at the time I wrote the call. I am usually looking to get a 4-5% return if unexercised and 15-20% if exercised when I sell a call. While I may regret selling the call later, it is only in retrospect that I can see that not writing the call would have been better. We would all be much better investors if we could invest in retrospect but we can't. We have to deal with what we know at the time. And I knew with 100% certainty that I was going to get the 4-5% call premium when I sold the call. I also knew there was a reasonable probability (less than 100% but certainly not zero) that I would earn the calculated 15-20% if the stock went up. And there was also a smaller probability (much less than 100% but still more than zero) that the stock could double or triple and I would be looking at a significant lost opportunity.

I am comfortable writing calls because I am willing to give up the low probability of very large returns (what Las Vegas offers) for the high probability of smaller returns. (Actually 4% per month is not that small if one keeps working at it.)

I believe it is Alexander Elder, in his book "Trading for a Living", who advocates writing down your expectations when you enter a trade. I don't keep a journal but at times like this I do go back and reconstruct the situation that existed when I entered a position and remind myself of what my expectations were at the time.

If I buy back the calls on my remaining April positions it will be at a loss, but the loss will only be about 25% of the profits that I have banked this year from call expirations in Jan, Feb, and March. And the real losses do not account for the gains on paper of the underlying equity that rose in price and got me into this fix in the first place. Overall I am significantly richer than I was two or three weeks ago. Don't the psychologists say that people experience more pain with their losses than they do pleasure with their gains?
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