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

To: Thomas Tam who wrote (3660)	4/13/2002 11:19:46 AM
From: Dan Duchardt	Read Replies (1) \| Respond to of 5205

Thomas, I have thought about this, but holding the puts long would not necessarily result in people holding to expiration. If the stock moves dramatically down, we would probably sell the put and take the gain, again over a short period of time. The mentality would probably be the same that we would hope to lock in profits and when the stocks runs up again we would be puts again to sell on another quick dip. Question is do we buy ITM or OTM puts, as this affects the amount of change with price variation? It is primarily because people are unlikely to hold until expiration that I think put buying could be more rewarding than selling calls. If you are holding options for a long time, the time decay works in your favor with short calls and against you for long puts. For anyone who is selling OTM calls with the idea of holding until expiration, come what may, there is not likely to be much gained buying puts and holding instead. For those who are flipping calls when they get the chance, the mentality is to sell calls when they think the stock has peaked, and to buy them back either when they think the stock has bottomed OR because there is simply no juice left in the short call. If the swings involved are large compared to the premiums involved, the advantage goes to the puts because of the shape of the price curve as the underlying changes. A long put never runs out of juice, and the deeper the stock goes the better for making near term income. If you are wrong about a peak, and the stock runs up on you, your rate of loss on the put diminishes. This is exactly what you would like to happen. Short calls do the exact opposite. When a stock drops the calls can't drop in price more than what you got for them, and the rate constantly diminishes. If the stock goes up your rate of loss on the calls increases until it completely negates your gain on the stock, and then you either take your loss or get called out. This is a very undesirable outcome for those who want to hold their core stocks forever and hope to profit from trading short calls. There will often be times when short calls work out better than long puts, but when the puts work out better they can be a lot better. Here is a case in point based on some incredibly rare good fortune I had. I don't own IBM, but based on market conditions and the chart I thought there was a chance it could drop. If I did own it, I might have been looking to sell a call. On March 26 APR105 calls (first OTM) were selling for about 2.30, and APR100 (first ITM) for about 5.50. Both are now essentially worthless. An alternative to selling the calls was to buy puts. I bought next OTM MAY100 put for 3.50. When IBM gapped down on April 8 I sold for 13.80 and used about half my 10.30 profit to buy APR90 for 4.90 figuring I would stop out if it lost a couple. On April 11 I sold for 6.40 and bought MAY80 for 2.00, so I'm now risking 2.00 of an 11.80 gain on the chance that we have not yet seen the worst. And if I did own IBM, I would not be sitting here with uncovered stock hoping it would go back up so I could sell calls again. The big gap in IBM is not something that happens every day, but 20% moves in a couple of weeks are not uncommon. So I think anyone who is writing CCs on stocks typically making strong moves might benefit from buying puts. I have not looked at the price history, but my guess is that if anyone was fortunate to have caught the QCOM peak around March 18-19 to sell some calls they would be happier now if they had bought some MAY40 puts, probably in the low two dollar range. A more aggressive trader might have bought the MAY45 puts for around mid 4 and be up almost 5 now. All I am suggesting is that anyone who has been doing less well than they would like with CCs against core holdings make the comparison themselves on the stocks they hold. As for what to buy, there are a couple of things to keep in mind. First is that time decay is working against you, so you don't want to go long puts that are nearing expiration. I bought the APR90 IBM only after making a handsome profit on the MAY100, and on a stock that had broken down badly with bad vibes about possible SEC investigations, etc. in a generally declining market. When I sold that I went back to May because April expiration is just getting too close. Another consideration is the rate of change with price, the delta. Take QCOM for example with the price now at 35.71. If you were selling calls now you would probably be looking at either the MAY35 (2.95, delta .58 or MAY40 (.95, delta .29). If your trading fees can stand it, you might go half and half for an average of 1.95, delta .44. The MAY35 put can be purchased for 2.30 with delta .42, so for any move during the next several days the price change of the puts will be just about the same as the average change for the calls. BUT, if QCOM drops the put delta will go up and your rate of gain will accelerate with the puts instead of declining with the calls. If QCOM makes a hard bounce your rate of loss will decline with the puts instead of accelerating with the calls. So what I would look for is a put that has comparable delta to the calls you might sell, far enough out so that time decay is of little consequence. I am looking more an more at ratio call selling i.e: 2 short calls to every 1 long common. More bang if the price dips and a little leeway if the stock wants to run a little. That will give you better returns that a simple CC when the market drops, but of course it still has the same problem that calls lose value more slowly as the stock price drops, and gain value more rapidly as the stock rises. Half of your calls are naked so if the price goes up you can lose more on the calls than you can gain on the underlying. It's quite a bit more dangerous than buying puts If the stock gaps way above your call strike you are in deep trouble. If it gaps way above your put strike you are still ahead overall, and a lot happier than even selling one for one near ATM calls. Dan

To: Thomas Tam who wrote (3660)	4/13/2002 5:37:43 PM
From: Allen Furlan	Respond to of 5205

Thomas and others on the thread. The idea of ratio writing is worth consideration of all. I have been doing this successfully for years. Moreover a strategy worth considering is hedging, after all selling covered calls is a conservative hedge strategy. Here is an example. Last July I bought emc at about 22 and ntap at about 13, sold OTM leaps in IRA account and also sold brcd 04/90(knuar) calls naked in margin account at about 8. Since then I have been adding to ntap and emc and selling more knuar at various prices. Over all the hedge has worked out very well except I am making money in margin and am slightly behind in IRA. The concept is embraced by hedge fund managers using mispriced stock in long and short positions. The advantage to small guys like us is that small positions using options are possible. Last weeks Barrons had the following observation "The big mutual fund complexes don't teach managers how to handle the short side, which is probably the biggest differential of hedge fund performance" Good luck to all.