Comfort with Covered Calls?

[NilesMike]

(12-15-2013, 09:14 PM)hendi_alex Wrote: Fees are negligible at TDA. Mine are $7.99 per transaction.

What fees are $7.99? Your stock purchase? Hopefully you're paying that for options commission. What about exercise/assignment fees? My option commissions are $1.50 per contract, no ticket charge. Assignment fee is $15.00.

With TDA as well on those.

[mjs_28s]

(12-15-2013, 07:30 PM)NilesMike Wrote: With 5 contract transactions, I assume you are paying a per contract commission and not one based on size. What is the assignment/exercise fee on the ones that are called away, if I may ask?

If it works for you, I'm not one to quibble. just too much work for too little gain for me while generating too large of a percentage going toward trading fees.

I use Schwab, maybe not the cheapest but I have other accounts there and they have a bricks and mortar that I can drive to as well. The brokers that are lower cost are really enough to matter at my volumes plus they lack a local office that I can walk into with issues rather than sitting on the phone or using some live text chat on the computer.

Stock trades cost $6.95 in or out so getting called just $6.95.

Options - it depends. If you combine transactions and do a buy/write all in one shot you pay the stock commission of $6.95 then you pay $0.50 per contract. This means that a 1,000 share buy with a CC sell in the same transaction would cost $11.95. If you get called out add another $6.95.

If you already have a stock that you hold and you are just selling contracts You pay like you are doing a buy/write. The initial commission just doing a CC is the $6.95 + $0.50 per contract. So if you already have a 1,000 share position then 10 contracts will cost you the same $11.95 as the buy/write all in one shot. Combining a buy with a write negates one of the $6.95 charges is all.

So if you ran a buy/write, or selling 5 contracts on an already held position, with 500 shares and 5 contracts that were called away and assuming a $20 share price you would see the fees taking about this much: $6.95 commission (combined) + $2.5 (options cost) + $6.95 when called out = $16.40 total transaction cost. $16.40 / 500 shares = $0.0328 per share. So if you wanted to net say $0.20 per share premium you would need a premium that was at least $0.24 or higher.

Per 1,000 shares your cost per share reduces to $0.0189 per share.

Of course, sometimes the SEC or some other fee gets added but that is typically just quarters here and there. For example - a 5 contract option sell had $0.02 per contract as some added fee (not broker related). Could have been SEC fee or maybe some market maker fee. Not sure but they don't really impact your costs enough to matter.

[NilesMike]

(12-15-2013, 09:58 PM)mjs_28s Wrote: So if you ran a buy/write, or selling 5 contracts on an already held position, with 500 shares and 5 contracts that were called away and assuming a $20 share price you would see the fees taking about this much: $6.95 commission (combined) + $2.5 (options cost) + $6.95 when called out = $16.40 total transaction cost. $16.40 / 500 shares = $0.0328 per share. So if you wanted to net say $0.20 per share premium you would need a premium that was at least $0.24 or higher.

Unfortunately, none of the example CCs had this type of return (.20 on a $20 equity), they were only 30-50% of that return and they were 76-88% probability of expiring OTM not 95% prob.

When dealing with these small returns, I've found that every bit makes a difference. In order to get the 1% return above, the probs get shaved against one's position, you cap your gain to get that probability and incur fees equal to 20% of your gain.

Again, if it works for you great. I don't think this is something very many DGI investors would do. Typical CC traders are looking for 1.5% net premium per month. The dividend stocks we typically use do not offer that kind of premium.

IMO if one wishes to start with CC they would benefit from using poor man's covered calls. Much less capital required, generating significantly higher % returns.

Good luck to all.

[mjs_28s]

"Unfortunately, none of the example CCs had this type of return (.20 on a $20 equity)..."

When dealing with these small returns, I've found that every bit makes a difference. In order to get the 1% return above, the probs get shaved against one's position, you cap your gain to get that probability and incur fees equal to 20% of your gain.

Again, if it works for you great. I don't think this is something very many DGI investors would do. Typical CC traders are looking for 1.5% net premium per month. The dividend stocks we typically use do not offer that kind of premium.

IMO if one wishes to start with CC they would benefit from using poor man's covered calls. Much less capital required, generating significantly higher % returns.

Good luck to all.
[/quote]

Pretty much everything you said is what I already stated.

I have already said that most people are looking for premiums that are higher. I also write most of my options far enough OTM to skim nickels while maintaining a pretty solid probability of not having shares called away.

"Unfortunately, none of the example CCs had this type of return (.20 on a $20 equity)..." Not sure what that means as I also stated that everyday the premiums will change based on time left AND market conditions. Plus you are changing my skimming nickels into trying to get 1% and since I did not give examples of pulling in 1% per month or more I don't quite understand your comment. You could just take the stocks I listed and write them all closer to ATM and you have your 1%+ income stream but a much higher chance of being called out. I am skimming income while minimizing the risk of having to take capital gains every month beyond the option premium. No reason for me to purposefully churn my stocks.

If one wanted to use the first one I listed, ABT, you could get a two strikes OTM today of $0.22 when on Friday it was $0.19 while the share price is up $0.15 on the stock itself. Also, I stated that I did NOT include dividends in the income side. If you manage to snag the dividend but not getting called you get an additional $0.22 turning your buy/write if done as I type into this:

Stock purchase $36.55, option $0.22@$38 strike Jan 18, $0.22 dividend = $0.44 income, or 1.2%. If you get called out before date of record on the dividend then you could pull in 0.6% premium + 3.96% cap gain in less than 30 days.

Move that to one strike OTM and you get your 1%+. As I type 1 strike OTM is:

Purchased @ $36.55, option $0.52@$37 Jan 18. This is close enough to assume I won't get the dividend so ignoring that and assuming called you get this out come: $0.52 premium = 1.42% income + $0.45 cap gain = 1.23% gives you a total of 2.65% for less than one month gain (your stock goes away before expiration so someone can steal the dividend in this scenario).

Am I misunderstanding your comment or something? Since my example was just made up to show how COSTS are dealt with I am not sure why you are mixing that in with a previous comment that as regarding other topics.

My point on the comment you are responding to was to show that on 500 shares, 5 contracts, that one needs to consider that you will have a total cost of $0.0328 that needs to be accounted for when trying to see if you want to write a specific contract or not. The $20 per share or $0.20 premium is only there as an example and I clearly stated that if you wanted to net $0.20, which yes is 1%. you would need to get a $0.24 premium and the minimum. In my case if I am willing to accept a premium of say 0.40% on a $20 stock, or $0.08 per share then I would need to find the strike that is paying at least $0.12 per share on 500 shares.

Most of my sales on 10 contracts so I am closer to a cost of $0.0189 per share that I have to consider. So to get the result that you misusing that I gave, just take the stocks I listed and change the strikes since they are from two to four strikes OTM just back them down to one to three OTM and you get more what you are looking for and, as shown with ABT in this very comment, you exceed the 1% premium while getting a minimum of a 2.65% cap gain if called out (excluding expenses since I have no idea what your costs are).

Lastly, "I don't think this is something very many DGI investors would do. Typical CC traders are looking for 1.5% net premium per month. The dividend stocks we typically use do not offer that kind of premium." A DGI investor would not be writing options for 1.5% premium per month. That is TRADING as you specified in the very next sentence. Investing and trading are two different things. I use dividend payers for my CC stocks as I want more income to redeploy. When premiums are not there I will still have the dividends coming in. If I used non-payers and premiums just were not there so I was not writing options then I am cash flowing nothing. My method is taking a 3% yielding stock and turning it into a 6% to 10% machine with low risk of being called out. The DGI part of my portfolio does NOT have options sold against the positions. CC trading and DGI investing are two very different things even if one trades options against DG stocks. Using DG stocks does not make one a DGI investor.

[jmortega]

Hello. I would like to know if anyone is doing Covered Calls that expire a year out. There's lots of discussions regarding Calls expering 2-3 months out, and mini options also. But I am intrigued on selling a covered call that expires on Jan 15. The income stream is immediate and the yield of the covered call + the dividend makes it very attractive. In addition, you have one year to not worry about whats going to happend. Possible boring stocks are: XOM, PG, PFE, JNJ, MCD. Do we care if the stock is called?

Thank you in advance for your input and opinions.

[ChadR]

I don't do covered calls out that far. The reason is too much risk. I would hate for one of my stocks to take off and miss out on all that upside. Now a put I'll sell a year out. I feel that I'm too conservative in my option selling to go a year out on a covered call.

[jmortega]

(12-23-2013, 11:24 PM)ChadR Wrote: I don't do covered calls out that far. The reason is too much risk. I would hate for one of my stocks to take off and miss out on all that upside. Now a put I'll sell a year out. I feel that I'm too conservative in my option selling to go a year out on a covered call.

Can you explain about selling a put out that far? What are the pros and cons?

Thanks,

[hendi_alex]

I know that selling puts is equivalent to selling a covered call. Still, I'm very hesitant to sell puts but take on covered call positions pretty regularly. The one distinction in my mind is this. If a play goes the wrong direction, like far south, a call is very easy to unwind, with the call showing a profit and the long showing a loss. But when being short puts in the same issue, it seems that as the price decreases and volatility increases, the put premium gets exaggerated. It becomes much more difficult to unwind a short put position without taken an over sized beating during very volatile price action. I never sell puts unless the shares are something that I absolutely want to own at the lower price, even if shares tumble much further.

[ChadR]

Lets take a favorite stock of mine and my largest holding PM. I currently think that it is under valued. A call a year out with a 10% upside doesn't really pay much. The $95 call at Jan '15 gets you $156 before commission. I don't like getting that small of an amount for selling a call a year out. I really think going up more than 10% has a pretty good chance of occuring. This is why in the new year I will most likely be buying more of PM. To get larger premiums, you need to sell closer to the strike price. Though doing so will cause you to lose out on dividend payments if the price goes up much and the call is exercised early. A year has too much uncertainity for me to sell calls.

The pros are much higher premiums for selling the longer calls. Selling a $95 call for March '14 only gets you $20 where the Jan '15 gets you $156. Also less commissions you have to pay when you sell one call a year instead of one every 3 months.

Selling longer term puts are great as long as you don't mind having your cash locked up long term. Though you will miss out on all the dividend payments. I've never had a put called early. They seem to always want to collect the dividends before giving me the stock.

Selling calls and puts on margin is something totally different. You will need someone that is a lot riskier than me to go over those options. No buying on margin for me. I know that I am possibly missing out on some very large gains, but the downside makes me not want to mess with it.

Hope this helps.

[Kerim]

I'm with you ChadR. I'm willing to explore it further, but I'm just not seeing the risk/reward balance being good enough for me to mess with my long-term portfolio. I'm more than happy to use a tiny amount of play money to experiment and have fun with options, but not as part of my dividend growth strategy.

[NilesMike]

(12-28-2013, 11:53 PM)Kerim Wrote: I'm with you ChadR. I'm willing to explore it further, but I'm just not seeing the risk/reward balance being good enough for me to mess with my long-term portfolio. I'm more than happy to use a tiny amount of play money to experiment and have fun with options, but not as part of my dividend growth strategy.

I think you have made a wise decision.

[Main Street Stock Investor]

Kerim,

I would like to share my experience with options. Thanks for posting the question. As background, I am an investor, but I do occasionally trade partial stock positions within my portfolio. I also write covered calls and LEAP's for extra income or insurance.

This example is an actual trade that was made in my portfolio and illustrates an option that expired worthless to the buyer of the option. I sold a LEAP option as described below, collected the premium and did not relinquish the 100 shares of stock. On November 21, 2007 I wrote a single covered call LEAP option on Eli Lilly and Co. (LLY) which, was trading at $50.35/share. I received $301.00 in option premium, and this income reduced my dynamic basis in the stock and went immediately into my core cash. The option had a strike price of $55.00 and an expiration date of January 2009 (a 13 month LEAP option). While I was waiting for the option to either expire or be exercised, I collected the dividend payments for the entire period. In January, 2009 the stock price was trading at less than the strike price of $55.00/share and therefore the option expired worthless to the buyer of the option. I retained the stock and the original premium of $301.00 from selling the option. The net result is that extra $301.00 equates to a 6% boost in annual returns ($301.00/$5,035.00 x 100) = 6%.
There are many variations to trading options, as an example, you can buy them back at a lower price, pocket the gain and keep the stock. You can also stagger the purchase of options within a portfolio, and so on.

Covered Call Options at Initial Purchase:
Using the same information from the previous example, but consider that we are just initiating our first purchase of 100 shares of LLY. We would simultaneously purchase 100 shares and write a 13 month covered call LEAP option. The stock purchase price is $50.35/share but selling the covered call paid a premium of $301.00 ($3.01/share). The net result is that the cost to purchase the stock would be $47.34/share. A 6% discount to the selling price.
Should the price increase above the $55.00 strike price, the option would be called and you would realize a $766.00 profit and the 100 shares of stock would be called away. This equates to an annual gain of 15% before you account for the dividends. When you add the 3.8% annual dividends paid in 2008, you realized nearly a 19% annual gain for your effort. If the option is not called at the expiration date, you hold the stock at a discount to the original purchase price. Writing the option at the time of purchase provides an additional margin of safety.

Covered Call Options as Insurance
Consider a fully functional portfolio and a given stock position that has built a 2/3 partial position of 200 shares and you are not considering selling the stock. The market has been quite favorable of late and we want to protect our gains. We like the gain, but we also like the dividends, we don't want to sell at this moment. But, we would also like some insurance to protect any market downside. If the stock went up to $55/share we would be happy to be a seller. If the stock goes down, we want some protection to preserve our initial gains. Selling a covered call will provide that insurance by putting cash into the core cash account and thereby lowering the cost basis and adding additional downside protection. If the stock goes up to $55/ share your option is called and you have made a good profit. If the option expires worthless to the buyer, you are ahead by the amount of the premium and you still own the stock. Either way you have provided a form of insurance to either lock in a gain or to provide additional downside protection.

Regarding portfolio tracking, I account for all dividend income, trading income and option income and use individual Excel worksheets to track all activity. There is an individual worksheet for each stock and these sheets feed a summary sheet to show total portfolio performance. This method of portfolio tracking is working well for me.

I have managed to systematically build dividend achiever and dividend aristocrat stock positions in my portfolio by reinvesting dividends, trading profit and option profit, then purchasing or selling partial positions based on technical indicators. My goal is to maximize profits from dividends, trading income and option income and at the same time continue to build stock positions. The ultimate goal is a very large and reliable dividend stream produced by holding high quality dividend stocks.

M$$I