TigerPaw, may I suggest a different strategy? Consider your total position. Here's a hypothetical example laid out in detail to illustrate the point.
Suppose you write a hypothetical covered call May $45 when the stock price is $40 and the premium is $2. Think of the sale of the call and the purchase of the stock as occurring simultaneously. I don't have a calendar in front of me, but let's say for the sake of argument that there are 52 days between now and expiration.
You have effectively purchased the stock at $38 ($40 -$2). You will make a profit if the stock closes at more than $38, and your maxim profit is achieved if the stock closes at the striking price or above. That's the point that many people forget. They erroneously believe they have lost money if the stock climbs higher than the striking price plus the premium. So your maximum profit is $7 on this position ($45 - $38) which works out to 18%.4% in just 7 weeks. If you annualized that rate of return you come up with a profit of 251% per annum. The mistake that so many people make is they forget that they need to create a new position at expirey, but instead simply buy back the options because the stock price is above the striking price, and convince themeselves that they have lost money. Let's put two hypothetical trades back to back to illustrate what I'm talking about. Suppose the first position ended as outlined above, but that the stock was called away because the price ended up at $47 at expirey. We have already established that the first trade earned 18.4%. Let's suppose that a second position is initiated with the same stock, but this time a July $50 (3 month) call is written against the stock, and a premium of $6 is received. Let's assume that the stock closes at $40 at expirey. So, the purchase price was $41 ($47 - $6), and the loss on the position was $1 ($41 - $40), or 9.76%. Compounding the positions gives us 6.9% for a 20 week period, or 18.9% annualized.
Had the stock been bought and held for this identical period the annualized return would have been only 6.6%. But both positions were profitable.
I discussed this example in detail because it clearly illustrates the problem that many people have with options. They compare their position with an inappropriate opportunity cost. In effect, the fall in love with the stock.
Hope this helps.
TTFN,
CTC |
