Covered calls have two main downsides:
1. Loss of upside profit if the shares get taken away during a move up. This obviously happened to many who wrote CCs during the Long March (the boom market of 1998-200). For example, the $2 return on a JUL20 is not so great if the shares are taken away at $20 while the stock itself is at $30. (As could easily happen if a recovery starts.)
2. Disincentive to sell if the shares are being held as the covered part of the CC. For example, collecting the $2 for the JUL20 and sitting on the shares until the expiration, even as Intel falls to $12. (As could also happen, e.g., if the War on (Some) Terrorists goes badly in Iraq, with "Blackhawk Down" types of hand-to-hand fighting in Baghdad, and the estimated costs balloons up to $200 billion or more.)
True, both of these downsides can be mitigated by taking the right action. If calls rise, they can be bought back (for a net loss). If the stock falls, other offsetting actions.
The main win for CCs is when a stock is not moving. Of course, I don't know when this is, and I don't have any special need for a continuing income (need, not desire, to be clear), so I don't write CCs.
By the way, writing CCs is a "pure" strategy in game-theoretic terms. To first order, it does not depend on the fraction of a portfolio written on. Which is why a few of us have said "If it makes sense to write CCs on a fraction of one's shares, it makes sense to write CCs on all of them." In for a penny, in for a pound.
Writing CCs on just a fraction is just a linear combination of writing on none and writing on all. It doesn't make the strategy any better.
Rolling over, which you mention, is just a variant. Again, those who rolled options on a long march up, or different options on a long slide down, had a good "run." As with doubling up or doubling down on a roulette wheel, the problem with the strategy is in knowing the next number on the wheel.
The underlying issue is the mathematics of "martingales." Web searches will tell you a lot about this. Basically, it's about why "betting machines" (strategies, algorithms, such as an algorithm where half the winnings are taken off the table and the rest is bet, allegedly "guaranteeing" a net win) don't work. (Except for the obvious meta-case: if betting machines don't work, what should one do? Be the house. Which is why Las Vegas and Monte Carlo and a lot of Indian reservations are doing so well.)
--Tim May |
