i think there are several ways to look at covered calls. first if you have a portfolio of stocks and want to generate extra income its a good idea. if you are buying stocks just to write calls it is a harder play. then you may as well just write puts. i have found that after a few months writes you end up having your good stocks called away and the stinkers you are left with wont bring enough premium to make it worthwhile. in any case your selection criteria should be the stock itself and not the options. i would suggest you use qqq or dia or smh because they have more strikes to select from.
Could I ask how you were able to develop this strategy? Did you figure it out yourself or are you following a strategy that someone else has already laid out? Could you suggest a website or book about covered calls that you found particularly useful? I learned about covered calls from Woodie, heres where you can download a zip folder of him talking about covered calls: http://193.203.240.46/woodiescciclub/Lecture/
I totally agree you about the strategy, because I am doing the same. My problem is the exit strategy. Usually I set the position up to be called away, but in the case that the stock moves against me I am trying to determine when I should start looking for the exit.
I also agree with you on this as well. Covered calls are kind of a flawed concept and let me explain why. Now before I say this I am in no way condoning it, People do make money doing this strategy and hey if it ain't broke don't fix it right? But here is my problem with it. The whole idea behind investing, and this is an investing approach, not a trading approach, is that you are looking for long term appreciation obviously right? Well, to do covered calls the optimal strategy would be to find stocks that either A, don't move and will just sit there or B move to the sold strike if you sold an OTM call. So let's use a $50 stock and say you sold a dec 50 call for 3 pts a few weeks back. You are hoping that the stock basically sits at 50 by expiration. But my problem with this is that you are defeating the purpose of investing. Isn't the purpose of investing to find stocks that will greatly appreciate over time. Why go through and do research to find stocks that won't move! It seems counterproductive does it not? However if the stock heads south then you are stuck holding the bag. Now you might say well, I'll just put a stop in. Well OK, let's say you do that, so you put a stop at 47. So you sell the stock at 47 then buy back the call for maybe 1 pt thereby losing money on this investment. Now what if instead of the stock dropping orderly, it gaps down to 30 because they missed earnings. Well, know your getting killed. Now let's look at the upside, like I said before your optimal move is for the stock to stay at 50 at expiration but what if it goes to 100? Well good for you right, you made a killing! Wrong. You lose the stock and only get to keep 3 of those 50 pts. So again I'm trying to figure out why someone would not just spend a little more time and try to find good stocks that will appreciate greatly over time. Say looking for a $50 that will be $300 two years from now. Why would you want to find a stock that you admit will go no where? That's like me putting money into a hedge fund that tells me their strategy is to find stocks that will never appreciate. That seems a little counterproductive doesn't it? All the people I know that used covered calls from 1995 to 2000 missed out on the entire bull market and those that used covered calls from 2000 to 2002 held the market all the way down. So you are eliminating all of the upside on your trades but accepting all of the downside. Even if you use stops remember you have unlimited risk. If unlimited risk doesn't bother you then why not just sell straddles or strangles? You are admitting that these stocks are not going to move and your not worried about gaps and straddles and strangles are for more lucrative then covered calls. I'm just looking at this from a risk to reward basis. The trade or investment simply doesn't make sense. Even to generate extra income. Look at it this way, if your goal is simply to earn the small premium on the call why not buy butterflies or condors. Think about it, it's the same thing, you can earn anywhere from 1 to 3 pts from the time premium and yet have NONE of the downside! On top of that you won't need to lay out all the cash for the underlying stock. So in this scenario you have the same reward with limited risk! Why would you want to exchange that for the same reward with unlimited risk? Again it makes no sense. Well, that's my two cents.
A question I have had about covered calls is. When a trader or whoever buys a call, does the MM offset his side of the transaction by buying the underlying stock. If so he would be creating a hedge by also creating a covered call from his side. I guess my question really is how often do MMs offset selling a call by buying the underlying? Or do they more often hedge with other options positions rather than the underlying?
Market makers are always looking to earn the edge on spreads. They will always seek to trade options against options. If that is not possible and they don't want short deltas, then they will buy the stock.
Thanks Mav, your posts are always really appreciated. That brings up one more question. At expiration who is holding what in the positions where there are thousands of positions in the OI.
More often then not retail investors sell their calls at expiration if they are in the money vs exercising them although this is no always the best thing to do since they might be able to get a better price through exercising vs paying the spread to the MM. So for the most part the MM's are holding the ITM calls in which they just exercise the options and are long stock come monday morning. It doesn't matter to them because they don't have to put up any money for the stock.
Mav, better late than never I am currently testing selling naked OTM puts S&P. Any ideas about defending such position if the market drops down dramatically ? Thx