How To Write Covered Calls - An Ongoing Real Case Study! Message Board

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Strategies & Market Trends : How To Write Covered Calls - An Ongoing Real Case Study!

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To: Herm who wrote (8332)	8/22/1998 2:22:00 PM
From: Wayners	Read Replies (1) of 14162

Well thanks for the nice comments. I thought I might get slammed. The one thing I didn't do very often was buy the cheap puts far out of the money at the same time the calls were written. The strike price to go with would be the support level beyond which we'd no longer describe the drop as a mere dip. There were many times I wish I'd done just that. Here's a real world example using NSCP and its prices during the last month or so. I'd say support was/is $22 1/2 and resistance was/is $30 for the period Aug to Oct that would work pretty well for writing covered calls. When NSCP was at about $30, the Oct $30 calls were worth $3.55 (I'm assuming historical volatility of 70% per annum, div yld of 0, interest rate of 5% and 63 days until expiration). Also when NSCP was at about $30, the Oct $22 1/2 puts were worth $5/8. So the net credit would be pretty good at $2.9375 and you've got real good downside protection on the stock. Lets say you bought NSCP at $27 two weeks before it runs to $30. If NSCP "tanks" you get most of your money back. Might lose $1 1/2 if that happens. But lets say you get called out instead assuming NSCP is at $32 at expiration. You get to keep the credit of roughly $3 per share which was earned in two months plus the capital gain of $3. Annualized that is $36 per year (best case--you have to get called out each time). And yes you have to wait the full two months to get called out which has been my experience even when the calls get deep in the money. Lets say you bought NSCP again at $27, ride it up to $30 again and you sell it at $30 and don't write calls or buy cheap puts. Instead you recognize the resistance level and you just flat out sell the stock. You sell the stock and collect the $3 capital gain and its taken 2 weeks (same period of time as in first example) to make that possible $3 capital gain instead of 2 months via the covered call method. Annualized return here is $3 x 26 which is $78, Annualized returns between the two really show the differences between the two methods and both methods utilize the same stock picking skills. $36 (best case) using covered calls and $78 just flipping the stock outright. Even if you buy the same put protection as in the first example at $5/8 each time, your return is still $61.75 compared to the $36. Now that is comparing apples with apples. It just seems to me that if you can recognize the support and resistance levels of $22 1/2 and $30, why diminish return through the complication of writing covered calls at all? Just flip the stock and achieve superior returns.

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