To: robert miller who wrote (2992 ) 5/30/1999 12:22:00 PM From: michael r potter Read Replies (1) | Respond to
Utilizing options on SFE. This is a basic discussion-and may provide no new information to those familiar with options. Additional income can be gained from selling call options on volatile stocks like SFE. High volatility =high premium. The option writer [seller]wants to capture those high premiums and get some downside protection on the underlying stock. Many among us have SFE with a very low cost basis, consider it a core holding, and don't want to sell it, even if it "gets way ahead of itself" due to excess short term enthusiasm. It is just at those times that call premiums tend to be extreme. Normally those emotional spikes are followed by a consolidation or pullback. Ideally we want to either buy back the calls cheaply or let them expire worthless. The ideal period to sell covered calls IMO is 3-6 weeks out. Example, if it is Mid to late June, sell the July out of the money calls. [options expire the third Fri. of every month]. It is during the last month of an options life that time decay is the fastest. The seller wants rapid decay. One of the objections to selling covered calls [especially on low cost basis stock] is " What if I am wrong and the stock keeps going-I don't want it called away." Lets look at an example of which I will best guess premiums. Backing up six weeks ago. SFE had just had a big run from around $40 to $90 in a month. We determine it to be a good time to sell calls. We chose to sell the six weeks to go April $105 calls for $4 [$400 for each 100 sh. written against. 1000 sh. =10 calls=$4,000]. The stock keeps running to $120. Just because it is above our strike price, [$105] does not mean our stock will get called away, and in fact it is very unlikely to happen with several weeks to expiration. The option will almost certainly be trading at a premium to its intrinsic value which means there is almost no chance it gets called away. We hang on. The stock settles down, pulls back and closes the April expiration at $73. The $105 call expires worthless. But, what if SFE stays up there and with one week to go from expiration, SFE is at say $110. In that case in order to insure that our stock does not get called away, we buy back the option for $6. In this case, we lose $2 on each call sold, but we still make an extra $20 on our SFE stock. Not a bad trade-off for being way to early. Now we can either do nothing, and wait for the next spike, or if we determine that it is still overbought, can immediately roll out and sell the June $120 call for $4 or $5. It is rare for stocks that have massive moves to not retrace a significant part of the move. I have been under-utilizing this strategy- but recently employed it with Tellabs. [Following figures given as if TLAB had not split-as the calls were sold pre split] Tellabs had just had a nice run to $118. I sold the 6 wk out June $135 calls for $2 5/8. Now TLAB is around $117 and the calls are down to $1. Part of the decline is due to time decay and part is due to the recent pullback in TLAB and the market which has dampened speculation. I expect the calls to expire worthless, but should TLAB make a massive run, I will buy them back and likely roll out. The danger of selling calls is to not get carried away and just start selling them as soon as our previous ones expire. In other words, I would not be selling covered calls on SFE now at $73 unless for some reason I was extremely bearish on its price for the next 4-6 weeks. Many of us have had multiple stocks that have been subject to emotional spikes and at those times, selling calls is a potentially profitable strategy if used with discretion. It does require some work and discipline, but maybe more work and discipline will be required to obtain outsized returns than has been the case since Oct. For traders the preferred strategy is probably to just trade in and out since preserving a cost basis is not an issue- the goal is short term gains period-taxes be dammed. Mike
