(09-26-2013, 07:06 AM)Kerim Wrote: Ok, I'll kick off this new options area by asking about how folks think about using covered calls with their dividend growth portfolios. I am intrigued by the strategy generally, but am just not sure how it is compatible with building a big portfolio, and a growing stream of income, over the years. Doesn't the specter of having your shares called away make it hard to build and track that portfolio?
One thing to consider to nearly eliminate your chances of being called out of positions is that as your portfolio grows the smaller premium you can rake in and have that smaller premium matter.
For example - if you have $25,000 of your portfolio that you use for CC writing you probably use one strike OTM or ATM to get a nice cash flow, which would make sense (if you are using monthlies as I do). These strikes will typically give you 2-4% depending on how you pick your stocks. Small premiums for further OTM calls barely make money over commissions.
But if your CC portion of your portfolio is say, $250,000, rather than trying to target 1 strike OTM or ATM you can move out to 2 strikes OTM. While the premiums are smaller you are doing this with more contracts per commission thus you can accept a lower premium return and do ok. With $250,000 if you are will to accept 0.4% per month, $1,000 cash flow, that means your strikes are far enough OTM that you will hold 95% of the time. IF you are doing this with dividend paying stocks you turn a 3% yielder into a 3% + (12 months * 0.4%) = 7.8% cash flow machine with very small risk of being called out. Nice thing to is that if you do get called out 2 strikes OTM, on a mega cap stock that pays dividends, you are still going to pull in a cap gain around 2 to 5% for one month, plus the premium.
While the 0.4% on $250,000 is much to small for some CC writers, I look at it as $1,000 per month extra income to direct to other investments (typically my core holdings) that I would not otherwise have. $12,000 adds up pretty quick.
Just think, when you get your CC portion to $500,000 you could reduce your acceptable premium percent return per month and still coin $1,500 per month to invest elsewhere.
Covered Calls only get sexier as you get more money to do them with as you can accept lower premiums on strikes farther OTM that what most people write. If you do it with stocks that already pay dividends you can create quite a nice cash stream with very tiny risk of being called out.
Good luck with your option writing!
(11-08-2013, 03:07 PM)jmjor Wrote: I toyed with covered calls for awhile. I read somewhere that 80% of all options expire worthless, so why not give it a shot. At first it worked out well, I sold the options, the market went down, either none were called or the ones that were I could almost immediately buy back at a discount (lucky!). I felt like I was so smart. Then I sold a new batch, the market went up and I missed out on very nice capital gains which I found out really bothered me. So I basically quit the practice except only rarely when I have a stock I've decided I wouldn't mind selling.
One thing to try in markets moving up after a drop is to ladder calls. Maybe write some 3 months out fairly far OTM, some 2 months out two strikes OTM, and 1 month out 1 or 2 strike OTM.
This way even though some stocks get called out you still have 1/3 of you CC portion coming due for rewriting or doing new buy/writes if called out.
"That sounds like a pretty good approach, jmjor. If I decide to lighten up my INTC holdings even more, maybe I'll use covered calls to do it."
That is a good idea too. When I knew it was time to take some profits but I was fighting an emotional affair with certain holdings I would sell ATM calls for parts of them to trim out in an unemotional way. If I was wrong, well I just had the same positions to write more calls on.