Buy write income strategy

Discussion in 'Options' started by Industry, Apr 29, 2011.

  1. Industry


    Hello everyone,

    I was curious whether a strategy that I recently concocted would be viable, profitable, and not take unnecessary hidden risk.

    It goes as follows: Screen for volatile stocks with high volatility premiums in the options. Companies that have volatile stocks (but not excessive risk of permanent loss of capital) make for the best selections i.e. not healthcare stocks with binary events in the near future and not small cap stocks that may be out of business in 6 months time.

    Strategy: Buy the stock, sell an equivalent number of at the money calls for the shortest dated expiration. Regardless of how the stock and options do at expiry, roll the strategy forward into the next closest expiration date.

    The strategy works because you collect the premium on the options, month after month. The way the stock moves is pretty irrelevant because the calls are rolled forward to the nearest expiration date with the highest call premium month after month.

    Trade example: EBAY
    Price: 34.25
    Option: May 11 Call
    Strike: 34
    Premium: 1.01
    (source: Yahoo! Finance)
    Days to expiry: 21

    Annualized return = (premium collected / amount invested) * (365 / days to expiry)

    1.01 / (34.25-1.01) * 365 / 21 = 52% annualized

    Sound like a good return for limited risk -- who cares if eBay tanks 50% you take the premium to make up for it. If it goes up 200% -- well, you missed some upside but the premiums are fantastic.

    And eBay is not likely going to go under in the next few years :D
  2. sjfan


    Um.... are you sure you thought this through?

    Say EBAY goes to $20 next month. You rewrite your call at $20. EBAY then goes to $25. You lost $14.25 on the stock less a few bucks of options premium. That's not coming back.... There goes your 52% annualized return.

  3. daveyc


    The same risk as just selling the puts, it will only make you money if the stock is either flat or goes higher.

    You should care whether the stock is cut in half by the way, this is a neutral/bullish strategy.

    Don't believe the seminal sellers that try to sell this strategy as a way to make your millions 'cause you will get desimated in the next bear market. If you need to own stocks and want to sleep at night, consider collars.
  4. spindr0


    Let's ignore the fact that premium decay is non linear (more premium per day closer to expiration) so you don't get to annualize by dividing 21.

    You sold an ITM call. Therefore your potential profit is $ 0.76 not $1.01 and your annualized return using your slightly exxagerative method is:

    .76 / (34.25-1.01) * 365 / 21

    which is more like 36% annualized
  5. spindr0


    Apr '08 ~ $33
    Dec '08 ~ $12

    down $21 in 7 months. Dya think the premium you brought in for writing monthly CC's is going make up for that?

    At $12 with the same implied volatility, an ATM call might bring in 20-30 cts of time premium. Annualization numbers will be similar but would you really want to give up $34 stock at $12 ???

    Time for another concoction? :)
  6. Substitute RIMM for EBAY and see how it would have worked if you did this yesterday.
  7. newwurldmn


    Which trader hasn't at some point in their career followed this line of reasoning?
  8. spindr0


    Yeh but he wouldn't have lost money on the calls

    :D :eek: :D
  9. rew


    As daveyc has already said, if you buy a stock and sell covered calls at the same time this is exactly equivalent to selling cash covered puts at the same strike price as the call -- except your broker gets to collect two commissions instead of one.

    Unless you are a short term trader in stocks I don't think you should buy a stock unless you think it's a good investment, and likely to go up (or at least stay where it is and pay a good dividend). Buying a stock simply because it has high volatility and thus high option premiums is almost always a bad idea. (And if you are a short term trader in stocks an option that takes a month to expire probably takes too much time for your trading style.)

    I will sometimes sell OTM covered calls on a stock I own to pick up a little extra cash, but I don't pick the stock because it has pricey calls. I'll also sell calls on a stock that went down and refuses to go back up just so I can make my money back on the damn thing, but that can take a while.
  10. Another victim that pay for 5K useless seminar that promise " get rich fast scheme by earning income in each month"

    Which seminar you are attending ?
    #10     Apr 29, 2011