HOW TO WRITE COVERED CALLS - A REAL CASE STUDY!
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Date: Thursday, March 06, 1997 SPLIT DAY!
Well, what a nice day! Sunny, no rain, clear blue sky in Florida and one fantastic 2-1 Split to boot! Our ROSS STORES (ROST) did pretty much what I expected. It split just shy of $50 down to $24.75+ and took off and never looked back UP $ 2 3/8 to close at $ 27 3/8 with a very nice volume of 804,300 shares which includes Steve's 100,000 share.
The VIX moved up a notch today up 1.44 to close at 22.88. So, the volatility is still a factor which will make those options more expensive. We should have higher than usual prices for calls during this expiration month. They is real good for writing covered calls. The calls started to go on bid today. DO NOT WRITE COVERED CALLS YET! To dangerous and still too cheap for us!
Just to give you an idea of the prices so far! The March 25s 2 1/2, April 25s 3 1/4, and the May 30s 1 1/4. DO NOT WRITE COVERED CALLS AT THIS TIME!
Everyone SHOULD KNOW WHAT THEIR ROSS NET COST BASIS IS before they begin writing calls! If not, get a hold of my free Excel template and plug in the numbers.
CONTROL YOUR TIME PREMIUM EROSION
1. As a buyer of calls! When you buy calls you should always buy the best value of calls. Notice, I said best value and NOT CHEAP! The best value for the money is "In The Money" calls. You should buy calls with longer terms options. Example, two or three months out! You should either sell the calls for the cash profit (trading options) before the expiration date or excercise the right to buy the stock itself! I like to buy three month out and sell on the second month to close out my position or take the money and run! That is, unless I know that I am going to excercise like I did with ROSS STORES. I excercised my right for 400 shares today! I can start writing covered calls tomorrow if I wanted to start.
2. As a seller (writer) of covered calls you want to put the time squeeze on your call buyers as much as possible. Out of the Money and In the Money covered calls decay at nearly linear rates. That means that the time really works against your call buyers and the price erosion works like pouring a can of Drano on ice cream! Melts away real fast! That is why I like the In the Money covered calls when volatility and downward price pressure is evident! I manage to stick it to my call buyers the majority of the time and keep their premies.
Selling At the Money covered calls should be avoided by keeping your net cost basis below the current selling price of the stock and/or just waiting until the price goes up a little before writing a call! The reason is because At the Money calls move at the square root of time. Meaning, if you double the time (one month, two months, three months, etc.) it only increased the price approximately 47% each time. Ex. 1 mo. option = 1.00
.....................................................................2 mo. option =1.47
.....................................................................3 mo. option = 1.78
That's good if you are a call buyer, bad if you are a call writer because you give an extra edge to your call buyer! It is not that hard to wait for the selling prices to shift to avoid the At the Money calls.
SUMMARY:
When writing covered calls try to write Out of the Money - one month out calls or In the Money calls one month out calls under normal random sideways and mild upward price movement. |
