Welcome stockycd,
As a relative newbie to call writing concepts myself, let me recommend that you visit here often, and do some back reading on this thread. There is some great stuff here from our host (Herm Matos) and several other very knowledgeable people who generously help us all understand the fundamentals and finer points of writing covered calls that will help you get the most out of the basic strategy you have outlined.
The scenario you have presented is not one that makes writing calls particularly attractive. I would far rather be the buyer of those August42_1/2 calls at 6_1/2 and sell them 4 months later at 11_1/2 or more for a tidy 76%+ profit than to be the guy who bought the stock and sold the calls. In fact, I would even prefer to just buy the stock at 42_1/2 and sell it 4 months later for 53 and take my 10_1/2 (25%) profit. In your scenario, you will have realized a gain of about 6_1/2 on an effective 36 invested (42_1/2 - 6_1/2) or 18% IF the option you have written is exercised. If you cover the option so you can keep the stock, you will have to come up with that 11_1/2 option price, which means that $53 stock will have cost you 42_1/2 - 6_1/2 + 11_1/2 = 47_1/2 (although you will have had the extra 5 to play with until August). In your scenario, you will have made a profit, a nice one at that, but substantially underperformed the market in that stock. This is one of those 20% cases where the option buyer is da winna!!
What will warm you heart is if DELL meanders around 42_1/2 for the next 4 months, you wind up still owning it in August, and your 36 investment is worth 42_1/2. You will have made your 18% on a stock that went NOWHERE! Besides, you will have had the comfort of knowing that if DELL slipped back a few points anytime before expiration day, you would still be making something instead of losing.
A compromise position would be to write the Aug47_1/2 calls for 4_1/2, which would protect you from a loss down to 38, but would increase your upside potential from the 6_1/2 in your scenario to 9_1/2 (i.e., the extra 2 you invest has the potential to increase your return by 5, but gives up some downside protection). That places you at a potential ROI of 25% on a par with the stock buyer, but with the huge advantage of the stock being nearly half way there at the outset!! DELL now only has to climb to 47_1/2 for you to realize the 25% gain instead of the 53 the stock buyer needs DELL to make. If you really are thinking in terms of DELL being at or above 47 in August, this is where you want to be.
If you need the protection in the beginning, and you do sell the August42_1/2, you can improve your position by covering those and selling higher strike price calls somewhere along the line. I won't repeat all the things you can find in the thread about when best to do this, but you would want to do this "repair" well before DELL hits 53. Or, if the price drops you can buy back the calls you sold at a lower price, and sell lower strike price calls to increase your downside protection and increase your gain if the stock does not rebound. I'll leave it to you to trace back for more details, but hopefully this gives you something to think about.
Dan
P.S. See what I mean.. In the time it takes me to draft this reply, some of the great minds have spoken!!! |
