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Strategies & Market Trends : The Covered Calls for Dummies Thread -- Ignore unavailable to you. Want to Upgrade?

To: Dr. Id who wrote (141)	4/22/2001 11:20:08 AM
From: Mathemagician	Read Replies (4) \| Respond to of 5205

One thing I've noticed about McMillan as opposed to most of our strategies with covered calls is that he advocates selling calls with much further out time horizons, while most of us who've posted are selling them for the current or following month. Any opinions on this? Further out carries much larger time premiums, and can lock your position up longer, but seems a safer play if you're disciplined with price targets at which you would close your position. Also, in this highly fluctuating market, it seems a better bet that you could cover your position at less of a loss if a stock runs away from you in the short term. When comparing premiums, be sure to adjust them so that the length of time is the same. A 3 month option appears to offer more premium than a 1 month option, but you can write the 1 month option 3 times during the 3 months. Thus, you should (at the most basic) multiply the 1 month premium by 3 when comparing. When selling CCs, you are selling time. Since the value of the option decays at the rate Sqrt(time), by selling shorter options you are always selling the most valuable time. All else being equal, it is usually best to sell shorter options for this reason. If that was unclear, try this exercise: 1. Pick a stock and a near-the-money strike price. 2. Figure out the difference in the premiums. 3. Figure out how many days are between each expiration date. 4. Divide the difference in premium by the difference in days for each expiration date. You now have an estimate of how much each day is worth in time premium. You will notice that closer days are worth more than days farther out. Example: 1. NTAP 25 Calls May 25 = 2.8 Jun 25 = 4 Sep 25 = 6.4 2. May - Apr = 2.8 Jun - May = 1.2 Sep - Jun = 2.4 3. May - Apr = 28 Jun - May = 26 Sep - Jun = 98 4. The 26 days between May and June are worth 2.8/28 = .10 each, on average. The 35 days between June and Sep are worth 1.2/26 = .05 each, on average. The 98 days between June and Sep are worth 2.4/98 = .02 each, on average. Now, which days would you rather sell? dM P.S. This is also an argument for buying the longest LEAPS calls and rolling out into the longest new LEAPS calls when they become available. That way, if you must buy calls you are at least buying the cheapest time. :)

To: Dr. Id who wrote (141)	4/22/2001 3:33:37 PM
From: Judith Williams	Read Replies (1) \| Respond to of 5205

Id-- McMillan...advocates selling calls with much further out time horizons....Any opinions? I think McMillan's contention is excellent proof that cc's are excellent for income but not so good as a hedge. In a volatile market I am just not comfortable with longer term option plays. Selling front-month calls gives you a little more control and you can then sell the following month's calls at expiration or roll them if the trade goes the wrong way. Take mathemagician's NTAP example. NTAP closed on Friday at 23.55, almost double its low of 12 or so on 4/4. If NTAP closes at May expiration at 25, you pocket 1.45 for the underlying and 2.8 for the call (excluding brokerage), for 4.25 total or 18%. You are betting that given NTAP's quick recovery since 4/4 it will not reach 26.35 by May expiration, a gain of less than 3 or about 12% in a month. For the Sept calls at 6.4, however, you are making a more pessimistic bet--that NTAP will gain only 6.4 in five months or about 27%. While the absolute time value is greater for the outlying calls, on a per-day or month-by-month basis it is not. And McMillan's thesis is even less help in sharply correcting markets--whether they are going up or down. In fast down markets the time premium does not make up for loss in the underlying and in fast up markets the underlying runs away from you. --Judith

To: Dr. Id who wrote (141)	4/22/2001 10:44:01 PM
From: JGoren	Read Replies (2) \| Respond to of 5205

ditto on the other two comments. reason folks are looking into the next month on calls is the volatility of the markets, esp. nasdaq, tech stocks. a few weeks is more easily predictable. moreover, the longer the option, there is a greater chance the stock price will temporarily go higher than the strike price and you could lose your stock even if it closes below the strike price on expiration date. on a shorter term option, there is less risk of a pre-expiration date exercise; folks just sell the option back into the market.