How much do you have to know?

Discussion in 'Options' started by gritsking, Mar 28, 2011.

  1. gritsking


    New member, first post. I know some of you folks can get downright testy if a thread isn't up to par, so I hope you'll cut me some slack with this very basic question.
    I am, it appears, the last remaining Buy and Holder of dividend paying stocks. I realized several months ago that I could add covered calls and increase the portfolio income. I had not done this before because of unwarranted concerns about the stocks being called and triggerig taxes and other bookkeeping chores.
    Now, knowing next to nothing, I have been happily selling calls several months out and finding:
    -they quietly and joyously expire, or
    -the market has a hiccup and goes down with the calls also decreasing and presenting the wonderful possibility of being bought in at a profit,or
    -the underlying approaches the strike price, whereupon one can roll out several months for a higher strike and, most amazingly, pocket some more cash!

    My question is: How long has this been going on?
  2. Magic8


    It has been going on... forever (until it doesn't)

    Covered calls can limit the performance of your portfolio.

    Your winners get called away - capping your return...

    While your losers drop in value... and stay with you.

    I would look at cash-secured puts on stocks you would like to own, at a discount. Same risk as covered calls.

    You can make up to 20%/year. Seems good, doesn't it? Except for the fact that the S&P can produce returns above that, in some years. ... making you wonder why you even wanted to play the options game... which I do, for some reason.
  3. The only real problem with covered call writing is that you have to get someone to buy your calls. That typically means sitting on a limit order for a while, or else taking a garbage price from the market maker. Depending on how you roll forward it could be better or worse.

    Other than that, it's good for a few extra points of return per year for a dividend portfolio with essentially no risk. It's a nice way to profit from the typical overpricing of volatility. You should consider adjusting your strategy so you DO get called out of the underlying occasionally. After all, there's some price so high your dividend investments no longer have a margin of safety. You probably wouldn't want to continue holding them in that case anyways.
  4. 1) Covered-writing works "best" in a sideways to slowly-uptrending market.
    2) You have to be willing to admit that you may have started out, from sheer dumb-luck and randomness, against a "good" backdrop. Your results and experience would be different if it were the year 1987, 1989, 1999, 2002, 2008 or 2009.
    3) Keep doing what you're doing but know that other types of sub-optimal, market scenarios WILL occur which may cause you to re-think what you are doing. :cool:
  5. That's called a "portfolio by adverse selection."

    After a good dose of that, one day you look at your holdings and you ask, "Where did I get this crap???"

    :) :eek: :D
  7. donnap


    Letting the days go by, let the water hold me down
    Letting the days go by, water flowing underground
  8. With a little more effort and saltiness, that could have been a decent limerick :)
  9. The caveat being that this strategy is implemented primarily on dividend paying stocks. That means unless they are forced to cut the dividend they are exactly the sort of stocks you would be buying if you had an empty portfolio - cheap and dividend paying. The two approaches work together.
  10. As mentioned by others, a covered call is the synthetic equivalent of a short naked put, and has the same risk/reward profile. The fact that the stock pays a dividend makes no difference… it’s priced into the cost of the put you are synthetically selling. If it were not so you could get free money by arbitraging between the covered call and the put, and all the free money is already arbed out of the market.

    Selling naked puts that are fully secured by cash is a good strategy for grinding markets, particularly if you can manage to sell them on pullbacks. However, as mentioned, you will significantly underperform during wild bull runs and you can expect significant drawdown’s during bear markets.

    It’s funny, I remember covered calls and selling verticals/iron condors was all the rage back in ’04 through early ’07, as though everyone had forgotten what happened in 2000-2002. Anyone blindly employing those strategies during ’08 and ’09 would have been murdered, giving back everything they had made during the good years and then some. Here we are a couple years later and everyone has a short memory… everyone’s talking about selling premium again. It’s amazing how quickly we forget and forgive… even Spitzer has his own TV show now, crazy world we live in!
    #10     Mar 28, 2011