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

To: Road Walker who wrote (1831)	8/8/2001 2:15:10 PM
From: Uncle Frank	Read Replies (1) \| Respond to of 5205

>> The primary mindset difference is that the buy/write trader should be willing to own the stock at the buy less the call price, where the covered call writer (IMO) should be willing to lose the stock, if the trade goes against him. Well put, John, but it doesn't address the the small set of folks who have captured extremely large gains in long term positions and won't accept a result that would trigger a taxable event. People in that enviable position tend to wait for peaks, sell further otm, and use repair strategies if they find themselves in danger of being called. duf

To: Road Walker who wrote (1831)	8/9/2001 12:36:27 AM
From: Dan Duchardt	Read Replies (3) \| Respond to of 5205

John, It goes beyond the mindset as well, to the strategy. If you are opening a buy/write, you attempt to make the trade at the lower part of the stock's range, where you are more likely to get taken out, and when the premiums are usually highest. Most covered calls writers, that want to retain their stock, try to write at the top of the range. A lot of posts have followed this one, so I thought a bit about moving my response to a later one. But since this is the one prompted what follows, I'll leave it here. Not to suggest that your statement is wrong, but I'm going to press my point and pose the following question: If you as a buy/writer would not act until you think that a stock is near the bottom of its range, then what argument can be made for holding a stock while it is falling and writing a call only when you think the stock is at the top of its range? In Uncle Frank's reply to you he pointed to one type of investor where this mindset makes some sense. A really committed long term buy and holder who wants to generate some income can do so by selling OTM calls when the stock appears to be at top of range. The premiums are generally not large, though they may be adequate if ones treasure chest of underlying stock is substantial. But this approach offers little in the way of protection against a market decline, and one can lose an awful lot of equity in the underlying waiting for that next top of range. I'm sure we all have horror stories from last year where bottom of range became a permanent condition. Unless you are dealing with very stable stocks, this is a very risky business. And that brings me back to the original question. Why would I sell a call that will make me $1 if I think the stock is going to drop $5 in a week or two? It only makes sense if I have the greatest conviction that the decline will be recovered, completely and maybe then some. If anybody has that kind of conviction in this economy, they either have a lot of resources, or a very long time horizon. Several people bought back calls today and made nice profits on their options trades. My congratulations and sincere best wishes to all of them. For many there is an assumption that they sold near top of range last time, and bought near the bottom, or at least here the call price is so low it's not worth the risk of holding for more, and will do it again next time, i.e., it can't get much worse than today so it's time to leave the underlying naked for the next run up. I'm no doom sayer, and I'm not making any predictions, but I can find a lot of savvy folks who think this break today is serious, and the bottom of range this time around is still a long way off. If they are right, or even if there is a reasonable probability of them being right, then the best thing these folks could do now is to think like a buy/writer and protect the downside. If they did that, and wrote some near ATMs at least a month out (preferably more, IMHO), and collected a decent premium, then there is of course the risk that many seem to dread that the stock will go back up and they will be called out. For those folks it might be good to review some repair strategies. I'll throw out a general guideline I picked up along the way. Others might want to quote the gurus or present their own thinking on this. A call buyer always has a "breakeven" point for his investment. It is the point where the stock reaches the strike price of the call, plus the premium paid to purchase the option. The stock must be above that point at expiration for the investment to pay off. As a call writer, this breakeven point is a target for taking action. At breakeven, you make a judgement about the future of the stock and decide to do nothing and risk losing it, or accept a small loss on the option you wrote and roll to another one at a higher strike or farther out in time. If you let the stock go much above breakeven, the roll up/out alternatives become far less attractive. Dan