Should CC be timed?

Discussion in 'Options' started by turkeyneck, Dec 28, 2007.

  1. I own the underlying stock and want to generate monthly income from selling front month OTC CC. Last month's CC expired worthless. Should I open another CC position immediately after expiration or CC should be timed?

    Also, would I be better off selling CC further out the calendar or selling front month CC month after month is the better strategy?

    Thanks!
     
  2. Of course, there are no absolute answers to your questions. Everything depends on you ability to predict the underlying stock movement.

    About the only thing I would suggest is not to always wait for expiration to setup your next CC play. Many times rolling to the next month prior to expiration is worthwhile. I like to monitor the roll spread and pull the trigger when I am comfortable with the net price.

    In my opinion, the price action should dictate your trades not the calendar.

    Don
     
  3. noone can tell you that without looking at the specific stock / option prices.

    Here's how i usually do it, am still learning as well.

    1) if i want to unload the underlying as well, i will sell covered calls with strike closest to ATM
    2) if on the fence on the underlying, i sell close to the resistence
    3) if want to keep the underlying, sell strike at 15% above resistence
    4) if the next month premium is more than 2.5x the current and there arent any significant news/reason baked in, i would go 1 additional month out.

    Also you need to look at the technicals, if the stock is just start to bounce off support to finish off a "W", be patient and wait before selling the call to maximize your profit.
     
  4. I'm going to out on a huge limb here and assume the objective of covered writing is to earn premium. Based on that assumption, you should be writing the call when you think it is the most expensive it will get that month.
     
  5. Monitor the spread b/t the current month's CC and next month's same strike call. If the spread is widening, time decay is doing its magic. If it starts narrowing, take a closer look. You don't want a Pyrrhic Victory where you get to keep every penny of this month's write but get bupkus for next month because the underlying moved too far OTM.

    Which month was the best one to sell is a hindsight conclusion. Selling the front month gives you more premium per day so if the stock cooperates and stays near the strike, it does best.

    However, if the stock were to drop a chunk, since the distant month offers a larger premium, it provides more downside protection. Conversely, if the stock were to rise a chunk, you'd be assigned ed sooner with the near term and would have a larger profit vis a vis time, particularly if it was an OTM write.
     
  6. What's your rationale for this 2.5x #?
     
  7. i am sure someone will correct me with their math. But i just use a very simple rule to come up with 2.5x.

    Theoritically say at beginning of month1, month1 premium is $1, month2 premium is $2, you basically make the same amount in 2 months period, but if selling month2 you will have to predict further into the future. Now if month2 premium is $2.5, then maybe it's worth it to skip month1 and sell month2 as that gives a larger premium.

    Yes not very scientific and there are many other factors like market condition and upcoming volatility predictions etc..
     
  8. The problem is, statistically a stock will not move twice as far in two months as it does in one month, because a lot of the random fluctuations cancel each other out. What you find in practice is that you get less premium per unit time as you go farther out. So, not even $2 for the second month, much less $2.50. Because statistically, there is less than double the risk.

    It generally takes some pretty unusual scenarios to get double the time premium for twice the time, like a major news event scheduled during the second month that produces an IV skew.
     
  9. FWIW, the time premium for an ATM option is roughly related to the square root of the time premium. Assuming no change in variables other than the passage of time, a 9 month option worth 3 will decay 1 pt to 2 in 5 months. The next point of time decay will take 3 months and the last pt will decay in the last month.

    For ATM's, unless there is some special news event coming up, you will not see 2.5X the time premium of the near month in the 2nd month. OTM is a different story.