Oddly enough I just explained in a series of e-mails to someone exactly how I go about this. He asked as part of another conversation, and I assumed it would be easy to explain. It turned out doing it was easier than explaining it. Also, this is by no means a rigorous approach. I do this with the same stocks all the time. It's easier for me to get to know something about a limited number of companies, even if its only to have a feel for how they trade. I'm aware of sites that give you the best percentage return stocks in a buy/write situation and have not used them, although I may give that more of a try in the future as that does look interesting.
I don't know if it would be helpful to anybody, but I'll go ahead and copy/paste a few paragraphs from those e-mails. Who knows, if I get rave reviews there could be a book in it. >G< Or maybe someone will burst my bubble and show me how it's just been an incredibly long lucky streak and I'd better take the money and run.
You'll be sorry you asked. That's ok though. No one hardly uses this board anymore so what the hell. I wrote this over about a week a couple of weeks ago.
Starts here:
Message 15767550
The above link is to a post by me some years back on a thread that was very helpful to me in determining what I wanted to do with options. My first recommendation would be to just start reading that thread at post #1. Some very smart people went through a lot of learning back then. In particular, Uncle Frank, Andrew Cothran, Faultline, Mathemagician, many others I can’t remember were very generous with their time and knowledge. Options can be very complicated, with spreads and synthetic positions and god knows what all, or they can be very straight forward. I did a little experimentation with some complicated stuff and decided it was not at all worth the effort, so I ended up doing covered calls on the stocks I owned at the time.
In my Interactive brokers account I own 2100 shares of QCOM. My average cost on these shares is $32.80 (total cost of roughly $70,000), with the cost ranging from $27 to $38, and the time frame ranging from Jan 2004 thru July 2005. My goal for these shares, in this account, is to end this year with approximately 1400 shares, at a cost of roughly $50,000, for an average cost of around $36 per share. The specifics of my cost are just the result of years of options activity, day trading, swing trading, wash sales. It just happens to be reality in this account. Also, my goal for this year has to do with my general life situation, as I am rebalancing things to reflect retirement. In other years my goal has been to accumulate as much QCOM as possible. I bring this up because I personalize all my trading activity. I find I can better formulate and follow through on a plan if I have a goal I state to myself (or write down) as part of the process. Typically the way I express this is “I will be happy if I sell 700 shares of QCOM this year”.
The next step is how much I want for my 700 shares. I have no idea what QCOM is really worth. While I’m remotely aware of things like discounted cash flow and price to earnings growth and various brokerage house targets, I don’t use those things any more than I use Tom’s risk areas or Zeev’s road map. At the beginning of the year QCOM was selling for around $47. Right now it’s selling for around $50. What I wrote down at the beginning of the year was that I would be happy if I received $41,000 for those 700 shares.
Okay, so far this year I have sold one Feb 50 contract and one April 52.50 contract. Actually, I sold the Feb contract 3 different times, and bought it back 3 times. In the end, I ended up putting the same amount of money in my pocket as I would have if I had just sold it once & let it ride for the 5 weeks, since it ended up expiring worthless. However, I didn’t know that & $50 is less than I really wanted anyway, and that 100 shares was at risk of being called away for a total of 2 weeks instead of 5. The April contract actually sold 4 different times so far, and I’ve again bought it back all 4 times. Like the Feb call, I have now put the entire initial premium in my pocket, while I have been at risk for only 4 of the last 20 trading days so far. I am willing and able to sell this call again, or some other call against these same 100 shares should I choose.
I can see where maybe this isn’t quite as simple to explain as I thought. It’s funny, because I look at the screen and it just jumps out at me. I’ve really just been screwing around with QCOM this year because the NTAP, OVTI, RMBS, SNDK & CREE have been doing so well-that is they have been called away at better than what I wanted-that QCOM has mostly been an after thought. I figured it would be easier to explain if I put down where I was now, and then as I did something I could show how and why I did it. Instead I’m beginning to sound like a blithering idiot and giving myself a headache to boot, not to mention buying some ISRG when I meant to sell (I hate when I do that). It’s ok though, I got out of it and even made a little on the deal. Still, sloppy isn’t good.
wanted to start over by saying that I have been liquidating the trading account since last November. My intention is to remove all of my own money, leaving the profits from the last 6 years. As such, many of the shares I would normally write calls against have been cashed in, and I have already established the positions I’m comfortable with for April. QCOM is by far my largest holding, both in this account and overall. Over the years it has also been the one stock I have written the most calls against. The reason I was going through such detail with QCOM is that I was sure I would find an option out there to illustrate my approach. When I looked at the various option chains, I found nothing. Part of what I do is not force anything. If I don’t find anything out of place or the premiums are too low I do nothing. Since I typically write 5-10 options a month on 2-6 stocks, it’s very rare that I can’t find anything interesting, although it’s also pretty normal that a stock or two is not pulling its option weight in any given time frame.
just put a day limit order to sell (1) Qcom April 52.50 call, for $0.80. One of my rules-in fact the one rule I never break-is not to do anything unless I would be completely happy with the outcome no matter how it goes. Since I am willing to sell 700 shares at some point this year, and would like to get around $60 on average, I could live with a first sale of $52.50, especially since the premiums to date plus the $80 today (should it sell) would put the return right at $55.05. Aside from wanting to sell anyway, today seems to be a good day to try it because QCOM is up right a long with the broader market. Let’s assume that I have no interest in having QCOM called away, just that I want to pocket the premium. Today would be a good day to get started because QCOM is up with the general market. If Q was up, but the market down, I would be less inclined to sell the call on the assumption that there was some news out there that I may or may not be aware of and that I may or may not be assessing correctly. If it’s going up by itself I would be more inclined to wait and see why. So, market up, stock up, no particular news, give it a shot on one contract.
So, rule number 1 is don’t do anything unless you will be happy with the outcome, NO MATTER WHAT.
Rule number 2 is NEVER SELL MORE THAN 1/3RD OF WHAT YOU ARE WILLING TO SELL AT ANY ONE TIME. This relates to why I would only sell 1 contract. Given that I have 700 shares, and all year do dispose of them, I would not want to be short more than 3 contracts (really 2, but since I have other shares I really would be willing to sell if the price spiked to $75 or some such, I’m likely to fudge on this rule a little). Ideally, the market will be up today, as will QCOM. Ideally, the one contract will sell today. Momentum being what it sometimes is, the same could easily be true tomorrow. If it is, I want to be in the position of selling the April 52.50 for $2.50, or the April 55 for $1.00, or the May 57.50 for ???. Similarly, I would like that possibility for a third day. After that, if the market wants to go to the moon, great. The uncovered shares I own will participate. If there is specific QCOM news it rarely takes 3 days to show itself, so even if it is a very well kept secret, I’ve only promised to give up 2-300 shares at pre-news prices. More likely-and this has by far been my experience-after a three day run the market pulls back. Since I pretty much only invest in high beta stocks, and since options tend to be a high beta product, it is often the case that I can buy 1-3 of those options back. When deciding to do this I will compare the % of the premium I get to keep to the time it has taken to get it. Typically, if I can put 50% of the premium in my pocket for 10% of the time, it’s an automatic. Since my commissions are low, I’ve been know to sell an option at .80, buy it back an hour later for .60, and then resell it yet again later that day, so the 50% return in 10% time is not a hard and fast rule, but just the way I think about it.
Lastly, why 0.80 for this option? When I first started out I would list the prices for an option I was interested in selling (say the 52.50 call), comparing the premiums for April, May, July, Oct, Jan 07, and converting each into $’s of premium per day. I would do this for all the stocks I owned, and that exercise really highlighted which options were POTENTIALLY more interesting. Typically the near month (April) will pay more per day (around $4 in this case) than those further out, in a reasonable smooth progression (May around $3.10, July around $2.90). Sometimes this is not true, and you will find that the May is paying $4.20, for example. I would then be inclined to sell the May for a couple of reasons, first because the per day premium was better and second because it allowed more time for the market to do a three day slide so I could buy it back. One caveat about this is that I would want to know if the increased premium was due to some expected event, generally known to the market-like a new product or expected great earnings, or ?-so that I could factor that into my decision. Regardless, I would recommend that exercise-comparing premiums on a dollar per day basis-to get a feel for the relative worth of these things.
I no longer do this in a rigorous way since it now tends to stand out, although I sometimes still do, especially if it’s a new company to me.
Anyway, why .80? I have sold this one for .80 to .90, four times so far, and have bought it back for .50 to .60, four times also. I have watched it trade as high as 1.10 and as low as .50. As the time premium erodes, I would expect to get less for it, so today if the price of the underlying moves enough so that the option would have gone to 1.10 2 weeks ago, it might only have .80 or .90 now. Also, .80 is well above the .50-.60 range it has been selling at the last 2 weeks. Also, I’m not particularly anxious about selling it, and I often put a day limit order in well above the ask and then go do something else (like go to work, historically). In fact, I’ll be surprised if it does sell. Not shocked, just pleasantly surprised. That’s okay. There’s always the next day or next month.
Anyway, I’m off to the gym to ride a stationary bike. I don’t get near enough exercise any more, but my appetite doesn’t know that. |
