Stops on covered call positions

Discussion in 'Options' started by hjcolvin, Jan 30, 2004.

  1. hjcolvin


    I am currently trading cc's, but I am concerned about the possible price decline in the stock. I was wondering if anyone had any advice about how/where to set your stop loss on this type of position.
  2. abogdan


    entry price minus premium?
  3. you have just hit on one of the problems with selling covered calls on stocks. when the stock sells off you lose a lot more than the premium you recieved plus you have 4 transactions. if you just sell the stock you are naked short a call and if the stock recovers you could get hurt on the call.
    if you try to hang on to the stock and just let the call expire you can end up in a position of not being able to sell a call above your stock cost so you sell a strike lower and end up locking in a loss in the trade.
    i dont recommend selling covered calls on stocks unless they are stocks you already own and you dont want to sell. i think a better way to go is to use the qqq. you have less risk of stock tankage and you have a strike every dollar that gives you more option choices to sell.
  4. AngusP


    hjcolvin - if the stock does tank you could try a repair strategy which to all intents and purposes is a short ratio call spread.

    Say the stock tanks from 120 down to 80. Your assessment is that it will recover and you don't want to sell, maybe for tax reasons or whatever. So for each 100 shares you could sell 2 calls at (say) 100 and buy 1 atm call at 80. The key is to pick strikes and series where you can cover the cost of the long call by the premium taken from the sale of the 2 short calls - you don't want to be putting more new money into it.

    If the stock rises, the recovery will be geared 2:1 because you will gain on both the stock and the long call. So if the stock rises to 100 you have gained 20 points on the stock and 20 points on the long call. The gain will be capped at 100, above which one of the short calls is covered by the stock, and the other by the second long call. But because the recovery is geared 2:1 you will have recovered the position to the original cost at 120, less the time value lost on the short call whilst held. And if the recovery doesn't happen, you've lost no new money because the strategy was put on for breakeven.

    If the stock continues to fall, or fails to recover, then both sets of options expire worthless, but the position was for free anyway. Same if the stock falls.

    just my two penn'orth.
  5. "Say the stock tanks from 120 down to 80. Your assessment is that it will recover and you don't want to sell, maybe for tax reasons or whatever. So for each 100 shares you could sell 2 calls at (say) 100 and buy 1 atm call at 80"

    how much do you think he will be able to sell calls for 20 points out of the money?
  6. Maverick74


  7. AngusP


    vhehn - that's why I added the proviso that you should choose strikes and series that enable you to put this on for nothing. I agree that in practice you won't buy an ATM call by selling 2 calls 20pts OTM, but the principle is there. Maybe sell 2 x 95's and buy 1 x 85 would be more realistic.
  8. Maverick74



    Here is the problem with doing that. First of all, in order to do the ratio for breakeven or for a credit you will have to do the 80/85 ratio spread. The 80/90 ratio will be a debit for sure. Now here is the problem.

    Let's say the stock recovers and goes from 80 back to 120. Well you just locked in a 35 pt loss. You missed the whole upside. All you made back was from 80 to 85. From 85 to 120 you are essentially long 200 shares and short 200 shares so you won't actually be making money from 85 to 120 right? You will be long 100 shares and long an ITM call which will be like 100 shares and the two short calls you have will be like being short 200 shares. So if the stock actually recovers, you will miss 95% of the recovery. This only works if the stock keeps recovering 5 pts at a time each month. Each 5 pts you will make the money back.
  9. I write calls on stocks I don't mind owning if I get stuck with them. I try to stick to very high quality stuff that I know will be around versus stocks with symbols like BOZO and CACA that might not be here tomorrow. The yield tends to be lower however.

    That said, my repair strategy is to evaluate the chart and the fundamentals, and then the calls I wrote. The nice thing about your stock going down is the call goes down too. So you can buy it back for cheap and roll down and/or out... being careful not to lock in a loss, or I suppose you could lock in a small loss if the stock is a dog from and you want to try and get rid of it.

    I do know that has a repair strategy calculator on the home page that will provide a free good idea.
  10. AngusP


    Maverick - I agree that it would be difficult to make this work with low IV at the moment, and if you could only put on the 80/85 ratio spread it wouldn't be worth it. But I was able to put on this position a couple of years ago on Abbey National (ANL), a UK banking stock. Share price was around 715 in Sept and 2x April 850 calls could be sold to buy 1 x April 750 call for a nominal credit.

    As it turned out I wasted my time because the stock continued to decline, hit my stoploss of 698 so I sold the stock and the long calls, and held the shorts naked to expire worthless! Got away with it but wouldn't do it now. Stock dropped to 300 and is now back at 580 :(
    #10     Jan 30, 2004