First time writing covered calls

Well coach I gave you wrong information on my trade. I didn't buy the stock at $40.20, that was a different trade. I already owned NOK stock that I had bought shares in Oct. and Nov for an average cost of $38.01.So on Nov 8 Nokia stock opened at $40.75, goes up to $40.80 then reverses. I didn't like what I saw and at 10:48.08 I sold a jan 09 LEAP sp 30 for $13. The stock dropped to $38.61 before closing at $40.08 I think I probably sold the call when the stock had dropped down from the high and broke $40. So what do you think is bad with this trade? If the leap gets called away I pocket $4299 on my $3801 investment. That is better than 10% and better than selling the stock at $40 for a $200 profit. The leap gives me $13 protection down to $25. And best of all in my view, if the stock drops and then starts to run up, I can buy back the short leap at a lower cost for a profit on that trade and still have the stock now at a lower cost basis.

 

Let me be clear that I dont think this is a BAD trade, just countering that be careful about claimng you add another 10% to your returns. You change the numbers a little so it is hard to keep up and the main point is lost. I went into the option pricer and gave you the benefit of the doubt on vols. NOK vols in NOV were no higher than 40% which means that the LEAPS would have had to have a skew up to 42% to get you the $13.00 which I cannot know now whether there was a positive or negative skew on vols going out that far into the future. At 40% or lower the option prices closer to $9 which makes sense.

Assuming your facts are right, you owned the stock at $38.01 and sold the JAN $30 call for $13 for a sales price of $43 or profit of $4.99. Profit of $4.99 is a return of 13% or an annulized return of 11%. You arbitrarily state that if you sold the stock at $40 you would only make $200 versus $500 rounded so the covered call was a huge boost to profit. However arbitrarily comparing a sales point to the CC does not make real sense here.

For example, lets assume I do the same thing and say that if you sold the stock at $45, you would make les with the covered call. Assume you sold the stock at $30. You would lose $8.00 versus making $13 at expiration. So I am not sure why you are stuck on comparing the CC versus selling at $40 unless you were locked in to sell at $40 which you are not. Therefore you cannot make a statement that selling the deep ITM CC adds 10% to your profit.

It adds something for sure the longer you go out in time but be careful of blanket statements. Given NOK vols it is a decent trade to make if you are willing to sit on the stock for 14 months and you do not expect much upside really. Downside hedge and and one can be happy with 10% return on the position annualized given current market conditions. However if the annualized return is 10%, I do not see how the CC ADDED 10% return to your position.

There is no point really in beating a dead horse. I do not disagree with the trade strategy at all so let me make that clear. You do deep ITM calls if it suits you but you have to go way out in time, well over a year to see any real premium given the delta and intrinsic value and is it up to you to decide if it is worthwhile to tie up the funds for 14 months for that total return.

I am sorry if I made it seem like it was a bad trade, just was countering that when you go deep ITM the bonus to the trade is minimal not a huge 10% bonus from the time premium, especially when counting in the time factor. A good hedge for potential downturns over time and if you are happy with the annualized return then set and forget it and this works well in IRAs and lightly managed portfolios. This is the beauty of options.

 

"There is no point really in beating a dead horse."

This is one of the most informative threads I’ve been involved with and if you have the time I would like to continue it. I’ve actively traded options for 5 years but in all honesty usually just trade them for leverage on momentum plays. I used to just scalp options on the cubes for the $10 spread. Although I am familiar with the greeks, I only use delta and IV in setting up my trades. I also don’t use skews in deciding which month to short, rather just the amount of $, which to me represents profit and downside protection ( which I think is important since the stock will drop faster than an ATM or slightly ITM call but not as much with the deeper ITM). AND if I am shorting a call, it is assuming the stock is dropping and I want to make more $ than just cashing out. So some of what you mention is over my head.

"You arbitrarily state that if you sold the stock at $40 you would only make $200 versus $500 rounded so the covered call was a huge boost to profit. However arbitrarily comparing a sales point to the CC does not make real sense here."

I don’t have access to a chart that shows the price of the stock at 10:48.08 am when I sold the call, but looking at the range for the day( opening at $40.75 and dropping to $38.61) and knowing Nok had been trading above $40 for the previous 2 days and I was expecting Nok to build a base at $40, if it broke that I would have gotten out of the trade. So the $40 figure is probably tack on and not arbitrary. Also, I almost never buy/sell from the mm’s so someone had split the spread on this I’m sure, which I realize effects this pricing.

It also seems to me that when I used to do calendar spreads buying ITM LEAPS and selling OTM calls 2 months out, even though I would collect the premium on the near month, the theta on my LEAP would leave my long position worth less than I had collected on the short call premium when the short expired. So it seemed to me, shorting deep ITM LEAPS was a good way to go when you don’t want to sell the stock, but have concerns about a big pullback and want protection

So, using the knowledge you have, what might you have done differently in this situation. This trade was done in my IRA, not my trading account.

 

I do not see anything wrong with the trade in a conservative account such as IRA if you felt NOK was at a minimum strong enough to not tank real hard down past $30 over the course of the year. You had locked in a profit over a wide range of prices in exchange for giving up any move above $43.

Do not go too far ITM as the premiums will dissappear fast. You went 2 strikes ITM which is not too bad althoughin % terms of the stock it was more than 20% OTM.

I would not always go out and buy stocks to sell deep ITM calls but if you already have a stock portfolio and you select the right stocks you can certainly add some profits for those stocks that end up range bound. For example if you saw NOK in a $35 - $45 range over the year then the ITM CC gave you a decent profit over most of that range. If NOK runs and you still like you can always buy more as a separate position. IN the IRA no need to worry about taxes and accounting so it is easier to do.