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

To: M. C. Orme who wrote (395)	5/2/2001 10:44:21 PM
From: FaultLine	Respond to of 5205

Comments on Rolling Down dmco, If share price would retreat close to that I would pay attention to uncover the call for a small amount and then resell at a lower strike. Probably at-the-money or in-the-money May 35. The idea would be to have the new premium absorb the cost of buying back as well as generate a little more cash. Yes, that is probably what I would do too. Protective Action to Take If Underlying Stock Declines in Price is discussed by McMillan on pp.62-70. He makes a good case for rolling down with statements like this: "The covered writer who does not take protective action in the face of a relatively substantial drop in price by the underlying stock may be risking the possibility of large losses [ on the total position ]. Since covered writing strategy is a strategy with limited profit potential, one should also take care to limit losses. Otherwise, one losing position can negate several winning positions." He clearly is concerned with capital preservation in the face of an adverse market. He goes on to say (emphasis mine): "The simplest form of follow-up action in a decline is to merely close out the position. This might be done if the stock declines by a certain percentage, or if the stock falls below a technical support level. Unfortunately, this method of defensive action may prove to be an inferior one. The investor will often do better to continue to sell more time value in the form of additional option premiums." That's clearly what you and I are talking about. He later points out: "Rolling down generally reduces the maximum profit potential of the covered call. Limiting the maximum profit may be a secondary consideration, however, when a stock is breaking downward.... the only case in which it does not pay to roll down is the one in which the stock experiences reversal -- a rise in price after the initial drop." This is what I'd worry about, chasing the darn thing up and down, up and down. I suppose that is the most pessimistic scenario but I've experienced a lot of aversion training this past year <lol>. It does encourage me though, that these hedging tactics, although not completely protecting one, are still better that just holding the stock alone and standing around while it drops through the floor. Rolling down though, does lock-in a loss if you are below the break-even point but it limits that loss too. Realize though that when buying one call and selling another you are executing a spread strategy. Be careful, you may get hung-up trying to leg-in one side at a time. These declining price situations we have been discussing point out why is best to only hedge stocks you might have wanted to own anyway. All we are doing is trying to calm and harness the Underlying's Inner Volatility -- sounds positively New Age doesn't it... In closing I'd like to toss out this idea: "Perhaps the best way to avoid having to lock in losses [by rolling down] would be to establish positions that are less likely to become such a problem. In-the-money covered writes on higher-priced stocks that have a moderate amount of volatility will rarely force the writer to lock in a loss by rolling down. ... conversely, low-priced stocks, especially nonvolatile ones, often present the most severe problems for the covered writer when they decline in price." [p.67] That’s why SEBL seems like such a good candidate for cc writing while I’m not so sure that CSCO provides the same opportunity (volatility) and security (higher price). This might be a fruitful area for discussion by the resident dum-dum-dummy illuminati. -dfl