Covered Call Strategies

[Packer16]

I was reading a chapter out of "The Warren Buffet Next Door" and one of the guys profiled was able to get very good returns writing covered calls and writing puts.  I think a few folks here have done this.  What are some of the parameters you look for when selling calls?  Any disasters to watch out for?  Do you do any naked strategies?  The genesis of the idea was to invert the call buying strategy which even when bought on Buffet stocks is a loss generator?  TIA

 

Packer

[plato1976]

Is this essentially a way to make profits from the time value ?

If so, currently both the volatility and the interest are so low, I guess it's a bad time to apply such a strategy ?

 

I was reading a chapter out of "The Warren Buffet Next Door" and one of the guys profiled was able to get very good returns writing covered calls and writing puts.  I think a few folks here have done this.  What are some of the parameters you look for when selling calls?  Any disasters to watch out for?  Do you do any naked strategies?  The genesis of the idea was to invert the call buying strategy which even when bought on Buffet stocks is a loss generator?  TIA

 

Packer

[DTEJD1997]

I have written covered calls from time to time...

 

Generally, I think it is a good strategy.  I especially like to write covered calls on stocks that I have large gains in.

 

Sometimes it backfires though.  A few years back, I bought Western Refining (WNR) at something like $3.90 a share.  It went up about $.75/share, so I wrote some calls with a strike of 5.  Worked great!  pocketed the premium.  Did it again, same result!  WNR then started to run, so I held off a bit...I was then sitting on over a double, so I wrote some calls with a strike of 10.  This time, WNR blew through it and the stock was called.  In the time after that, WNR went into the 40's.  So I lost a lot of the upside...

 

I think if you are judicious, covered call writing could reduce volatility and add a couple points of return to your portfolio.

[rkbabang]

I have written covered calls from time to time...

 

Generally, I think it is a good strategy.  I especially like to write covered calls on stocks that I have large gains in.

 

Sometimes it backfires though.  A few years back, I bought Western Refining (WNR) at something like $3.90 a share.  It went up about $.75/share, so I wrote some calls with a strike of 5.  Worked great!  pocketed the premium.  Did it again, same result!  WNR then started to run, so I held off a bit...I was then sitting on over a double, so I wrote some calls with a strike of 10.  This time, WNR blew through it and the stock was called.  In the time after that, WNR went into the 40's.  So I lost a lot of the upside...

 

I think if you are judicious, covered call writing could reduce volatility and add a couple points of return to your portfolio.

 

I had a similar experience with MIDD.  I held MIDD with a cost basis in the single digits.  I would write covered calls frequently and it was easy money until I had it all called away at $80 a few years ago, its up over $200 now.  I should have bought it right back but I wanted to wait until it went bellow $80 to do so.  It never did.

[boilermaker75]

I write naked puts. I make heavy use of the weekly options and 90% of my open positions expire in a month of less. I am collecting premiums for writing insurance. So if I am judicious in the puts I write, like Ajit is with Cat policies he writes, I'll do all right. I have one major advantage--when I have to pay on a policy I am getting a good or great business.

 

I currently have open short put positions on COH, ACN, EXC, BAC, MDT, PSX, JPM, KO, IBM, BRK/B, MCD, ORCL DTV, and KLIC.

 

I rarely get put to. When I do I sometimes keep the position. 25% of my portfolio is BRK/B and 10% WFC, all of which was acquired by being put to. Other times I write covered calls.

[racemize]

I write naked puts. I make heavy use of the weekly options and 90% of my open positions expire in a month of less. I am collecting premiums for writing insurance. So if I am judicious in the puts I write, like Ajit is with Cat policies he writes, I'll do all right. I have one major advantage--when I have to pay on a policy I am getting a good or great business.

 

I currently have open short put positions on COH, ACN, EXC, BAC, MDT, PSX, JPM, KO, IBM, BRK/B, MCD, ORCL DTV, and KLIC.

 

I rarely get put to. When I do I sometimes keep the position. 25% of my portfolio is BRK/B and 10% WFC, all of which was acquired by being put to. Other times I write covered calls.

 

What's the annual rate of return for the puts, e.g., if you never got put to?  Is this in a taxable account?  It would seem like the marginal tax rate would be killer for this strategy, unless the returns are very high.

[boilermaker75]

I write naked puts. I make heavy use of the weekly options and 90% of my open positions expire in a month of less. I am collecting premiums for writing insurance. So if I am judicious in the puts I write, like Ajit is with Cat policies he writes, I'll do all right. I have one major advantage--when I have to pay on a policy I am getting a good or great business.

 

I currently have open short put positions on COH, ACN, EXC, BAC, MDT, PSX, JPM, KO, IBM, BRK/B, MCD, ORCL DTV, and KLIC.

 

I rarely get put to. When I do I sometimes keep the position. 25% of my portfolio is BRK/B and 10% WFC, all of which was acquired by being put to. Other times I write covered calls.

 

What's the annual rate of return for the puts, e.g., if you never got put to?  Is this in a taxable account?  It would seem like the marginal tax rate would be killer for this strategy, unless the returns are very high.

 

In my IRA I am averaging 18% per year. All I do in my iRA is write naked puts and, if put to, write covered calls.

 

It is a little harder for me to estimate my return in my taxable accounts from my put writing because these accounts are a mix of LTBH positions and option writing. But I am sure it is higher because in some of my taxable margin accounts I will use leverage. Often, although not currently, I will write more puts than cash available.

 

Edit: Here is the negative. On October 11 I wrote the PSX November 57.4 puts clearing $1.43 per share, a 2.55% profit in about 5 weeks. But PSX is currently trading at $68.11. I look at this strategy as giving up some upside for a little reduced risk, the put premium plus the amount the put is out-of-the money when I write it. If all the positions I were writing puts on behaved like PSX I would change my strategy!

[racemize]

In my IRA I am averaging 18% per year. All I do in my iRA is write naked puts and, if put to, write covered calls.

 

It is a little harder for me to estimate my return in my taxable accounts from my put writing because these accounts are a mix of LTBH positions and option writing. But I am sure it is higher because in some of my taxable margin accounts I will use leverage. Often, although not currently, I will write more puts than cash available.

 

LTBH = Long term ___ Holdings?

 

I presume there is no getting around the put writing premium being short term holdings though right?  With a high marginal tax rate, that is pretty killer on after-tax returns.

[enoch01]

As a general rule it looks like humans are not great insurance writers - maybe it's hard to resist the "free" money?  Finding undervalued stuff seems hard enough.  Bearing that in mind and not trusting myself in this arena much, I've never written calls or puts.  I've only bought them.

 

I have given some thought to writing puts on stuff that has crashed hard, and that I think is under priced (JC Penney recently), but I've never pulled the trigger.

[hyten1]

boilermaker75,

 

i also do some put writing. however i don't see how you can get 18% return !?

 

usually weekly options have very small premium, i guess due to the nature of the market (up) you rarely get put to?

how much of a discount do you typical write puts for in terms of the strike price?

 

 

i guess i have been very conservative in terms of put writing. usually the strike price is a lot lower than the stock price (20 to 50%) or its long dated so i can get enough yield (usually i want at least 10% return annualized in order for me to write the puts)

 

what about you? what do you typically do?

 

thanks

hy

 

I write naked puts. I make heavy use of the weekly options and 90% of my open positions expire in a month of less. I am collecting premiums for writing insurance. So if I am judicious in the puts I write, like Ajit is with Cat policies he writes, I'll do all right. I have one major advantage--when I have to pay on a policy I am getting a good or great business.

 

I currently have open short put positions on COH, ACN, EXC, BAC, MDT, PSX, JPM, KO, IBM, BRK/B, MCD, ORCL DTV, and KLIC.

 

I rarely get put to. When I do I sometimes keep the position. 25% of my portfolio is BRK/B and 10% WFC, all of which was acquired by being put to. Other times I write covered calls.

 

What's the annual rate of return for the puts, e.g., if you never got put to?  Is this in a taxable account?  It would seem like the marginal tax rate would be killer for this strategy, unless the returns are very high.

 

In my IRA I am averaging 18% per year. All I do in my iRA is write naked puts and, if put to, write covered calls.

 

It is a little harder for me to estimate my return in my taxable accounts from my put writing because these accounts are a mix of LTBH positions and option writing. But I am sure it is higher because in some of my taxable margin accounts I will use leverage. Often, although not currently, I will write more puts than cash available.

 

Edit: Here is the negative. On October 11 I wrote the PSX November 57.4 puts clearing $1.43 per share, a 2.55% profit in about 5 weeks. But PSX is currently trading at $68.11. I look at this strategy as giving up some upside for a little reduced risk, the put premium plus the amount the put is out-of-the money when I write it. If all the positions I were writing puts on behaved like PSX I would change my strategy!

[boilermaker75]

In my IRA I am averaging 18% per year. All I do in my iRA is write naked puts and, if put to, write covered calls.

 

It is a little harder for me to estimate my return in my taxable accounts from my put writing because these accounts are a mix of LTBH positions and option writing. But I am sure it is higher because in some of my taxable margin accounts I will use leverage. Often, although not currently, I will write more puts than cash available.

 

LTBH = Long term ___ Holdings?

 

I presume there is no getting around the put writing premium being short term holdings though right?  With a high marginal tax rate, that is pretty killer on after-tax returns.

 

Long Term Buy and Hold (LTBH)

[ERICOPOLY]

In my IRA I am averaging 18% per year. All I do in my iRA is write naked puts and, if put to, write covered calls.

 

It is a little harder for me to estimate my return in my taxable accounts from my put writing because these accounts are a mix of LTBH positions and option writing. But I am sure it is higher because in some of my taxable margin accounts I will use leverage. Often, although not currently, I will write more puts than cash available. 

 

LTBH = Long term ___ Holdings?

 

I presume there is no getting around the put writing premium being short term holdings though right?  With a high marginal tax rate, that is pretty killer on after-tax returns.

 

For taxable accounts, it is extremely lame that gains from expiring (that you've written) puts are always taxed at short-term basis (regular income tax rate).

 

Instead of writing the cash-covered puts, you can write covered calls.  This way, when you make a gain it can come in the form of a long-term capital gain on the underlying stock.

 

Example:  Buy BAC share at $15 and write $15 strike call for $1.50.  If underlying stock finishes at $16.50 or higher, you have a long-term capital gain on the common stock when you close it out after 12 months.  So you made the profit, but you took the profit as a long-term gain.

 

This works great when there is put-call parity so no special advantage to going to puts route.

[boilermaker75]

boilermaker75,

 

i also do some put writing. however i don't see how you can get 18% return !?

 

usually weekly options have very small premium, i guess due to the nature of the market (up) you rarely get put to?

how much of a discount do you typical write puts for in terms of the strike price?

 

 

i guess i have been very conservative in terms of put writing. usually the strike price is a lot lower than the stock price (20 to 50%) or its long dated so i can get enough yield (usually i want at least 10% return annualized in order for more the write the puts)

 

what about you? what do you typically do?

 

thanks

hy

 

 

 

hy,

 

When I write a put with an expiration date about a month away I look for >1% return for that month. I can often find situations where I can do much better than this, like COH and IBM recently right after earnings. See my posts in the COH thread where I think I mentioned some positions I wrote.

 

Weekly options have the highest annual percentage returns. Look at the IBM 180-strike Nov 22 expiration puts. They are bid at $0.80. (They were a lot higher earlier this morning.) If I trade at IB, I'll usually get a fill that after commissions will still result in $0.80 per share. So my return for 8 days would be 0.46%. Note if I get put to at IB there is no commission for the stock purchase so it is also a good potential limit order if you wanted IBM at $180.

 

I'm usually looking at a strike price that is at- or just out-of-the money for an expiration date that is 1-8 days away. For some longer term puts I will look at strike prices a few percent out-of-the money.

 

Boiler

 

 

[rkbabang]

boilermaker75,

 

i also do some put writing. however i don't see how you can get 18% return !?

 

usually weekly options have very small premium, i guess due to the nature of the market (up) you rarely get put to?

how much of a discount do you typical write puts for in terms of the strike price?

 

 

i guess i have been very conservative in terms of put writing. usually the strike price is a lot lower than the stock price (20 to 50%) or its long dated so i can get enough yield (usually i want at least 10% return annualized in order for more the write the puts)

 

what about you? what do you typically do?

 

thanks

hy

 

 

 

hy,

 

When I write a put with an expiration date about a month away I look for >1% return for that month. I can often find situations where I can do much better than this, like COH and IBM recently right after earnings. See my posts in the COH thread where I think I mentioned some positions I wrote.

 

Weekly options have the highest annual percentage returns. Look at the IBM 180-strike Nov 22 expiration puts. They are bid at $0.80. (They were a lot higher earlier this morning.) If I trade at IB, I'll usually get a fill that after commissions will still result in $0.80 per share. So my return for 8 days would be 0.46%. Note if I get put to at IB there is no commission for the stock purchase so it is also a good potential limit order if you wanted IBM at $180.

 

I'm usually looking at a strike price that is at- or just out-of-the money for an expiration date that is 1-8 days away. For some longer term puts I will look at strike prices a few percent out-of-the money.

 

Boiler

 

 

It seems like you would get put to quite often with that strategy.  How often does this happen?  Half the time?  Less than half?

[boilermaker75]

As a general rule it looks like humans are not great insurance writers - maybe it's hard to resist the "free" money?  Finding undervalued stuff seems hard enough.  Bearing that in mind and not trusting myself in this arena much, I've never written calls or puts.  I've only bought them.

 

I have given some thought to writing puts on stuff that has crashed hard, and that I think is under priced (JC Penney recently), but I've never pulled the trigger.

 

BRK is one of the rare exceptions, a company that only writes insurance policies when the premiums compensate for the risk.

 

So far (>10 years) I have been able to do that with option writing. I am always in a situation where I would be comfortable being put to on all my open positions, even in the past when that would have put me on margin, which has happened.

[boilermaker75]

boilermaker75,

 

i also do some put writing. however i don't see how you can get 18% return !?

 

usually weekly options have very small premium, i guess due to the nature of the market (up) you rarely get put to?

how much of a discount do you typical write puts for in terms of the strike price?

 

 

i guess i have been very conservative in terms of put writing. usually the strike price is a lot lower than the stock price (20 to 50%) or its long dated so i can get enough yield (usually i want at least 10% return annualized in order for more the write the puts)

 

what about you? what do you typically do?

 

thanks

hy

 

 

 

hy,

 

When I write a put with an expiration date about a month away I look for >1% return for that month. I can often find situations where I can do much better than this, like COH and IBM recently right after earnings. See my posts in the COH thread where I think I mentioned some positions I wrote.

 

Weekly options have the highest annual percentage returns. Look at the IBM 180-strike Nov 22 expiration puts. They are bid at $0.80. (They were a lot higher earlier this morning.) If I trade at IB, I'll usually get a fill that after commissions will still result in $0.80 per share. So my return for 8 days would be 0.46%. Note if I get put to at IB there is no commission for the stock purchase so it is also a good potential limit order if you wanted IBM at $180.

 

I'm usually looking at a strike price that is at- or just out-of-the money for an expiration date that is 1-8 days away. For some longer term puts I will look at strike prices a few percent out-of-the money.

 

Boiler

 

 

It seems like you would get put to quite often with that strategy.  How often does this happen?  Half the time?  Less than half?

 

Not really, this is just a guestimate but less than 10%. I don't write puts unless the strike price is attractive. I probably won't be put to on any of my put positions that expire this week, ACN at $75, COH at $50 and $52.50, BAC at $14, MDT at $45 (this was a position I wrote in July), IBM at $180, BRK/B at $115, KO at $39 and $39.50, MCD at $97.50, PSX at $57.50, EXC at $28, KLIC at $12, and DTV at $60.

 

My other open put positions are Nov 22 MCD at $97 and $98, Nov 29 IBM at $170, and for Dec. so far PSX at $57.5, $BRK/B at $115, and BAC at $14. I also have ORCL $35-strike December covered calls, which is equivalent to a naked put. ORCL was one I was put to at $34.50 and I replaced with some lower basis ORCL and I want to be called out.

[turar]

For covered calls, do you guys usually write month or two out, or longer calls? Any LEAPs?

[value-is-what-you-get]

For covered calls, do you guys usually write month or two out, or longer calls? Any LEAPs?

 

I don't like to go more than two months since the decay (profit) really kicks in within that period.  You can shorten it right up to weekly options as well.

 

I also like to wait for some high volatility to increase the premium - ie some options are just not worth writing if there is a risk of volatility spike.  IBM was a recent opportunity I took to write puts.  Figured I would be willing to buy it at an 18% discount to WEB average cost! ;D ;D

[constructive]

The genesis of the idea was to invert the call buying strategy which even when bought on Buffet stocks is a loss generator?

 

What makes you say that? Did you read something that said buying calls on Berkshire owned or Buffett type stocks was a bad strategy? Seems doubtful to me.

[gr33ngi4nt]

boilermaker75,

 

i also do some put writing. however i don't see how you can get 18% return !?

 

usually weekly options have very small premium, i guess due to the nature of the market (up) you rarely get put to?

how much of a discount do you typical write puts for in terms of the strike price?

 

 

i guess i have been very conservative in terms of put writing. usually the strike price is a lot lower than the stock price (20 to 50%) or its long dated so i can get enough yield (usually i want at least 10% return annualized in order for more the write the puts)

 

what about you? what do you typically do?

 

thanks

hy

 

 

 

hy,

 

When I write a put with an expiration date about a month away I look for >1% return for that month. I can often find situations where I can do much better than this, like COH and IBM recently right after earnings. See my posts in the COH thread where I think I mentioned some positions I wrote.

 

Weekly options have the highest annual percentage returns. Look at the IBM 180-strike Nov 22 expiration puts. They are bid at $0.80. (They were a lot higher earlier this morning.) If I trade at IB, I'll usually get a fill that after commissions will still result in $0.80 per share. So my return for 8 days would be 0.46%. Note if I get put to at IB there is no commission for the stock purchase so it is also a good potential limit order if you wanted IBM at $180.

 

I'm usually looking at a strike price that is at- or just out-of-the money for an expiration date that is 1-8 days away. For some longer term puts I will look at strike prices a few percent out-of-the money.

 

Boiler

 

 

It seems like you would get put to quite often with that strategy.  How often does this happen?  Half the time?  Less than half?

 

Not really, this is just a guestimate but less than 10%. I don't write puts unless the strike price is attractive. I probably won't be put to on any of my put positions that expire this week, ACN at $75, COH at $50 and $52.50, BAC at $14, MDT at $45 (this was a position I wrote in July), IBM at $180, BRK/B at $115, KO at $39 and $39.50, MCD at $97.50, PSX at $57.50, EXC at $28, KLIC at $12, and DTV at $60.

 

My other open put positions are Nov 22 MCD at $97 and $98, Nov 29 IBM at $170, and for Dec. so far PSX at $57.5, $BRK/B at $115, and BAC at $14. I also have ORCL $35-strike December covered calls, which is equivalent to a naked put. ORCL was one I was put to at $34.50 and I replaced with some lower basis ORCL and I want to be called out.

 

With all those positions, how do you size them? Heaven forbid, what if you got put to on all your positions? What would your portfolio look like then? What hurdle rate to you tend to aim for?

 

Whenever I write puts (I am a novice at this), I make sure that the underlying would not cause me to go on margin if I were being put to. I also would only have about one or two put contracts open. I'm probably too concentrated...

 

Thanks Boiler!

[BargainValueHunter]

boilermaker75,

 

i also do some put writing. however i don't see how you can get 18% return !?

 

usually weekly options have very small premium, i guess due to the nature of the market (up) you rarely get put to?

how much of a discount do you typical write puts for in terms of the strike price?

 

 

i guess i have been very conservative in terms of put writing. usually the strike price is a lot lower than the stock price (20 to 50%) or its long dated so i can get enough yield (usually i want at least 10% return annualized in order for more the write the puts)

 

what about you? what do you typically do?

 

thanks

hy

 

 

 

hy,

 

When I write a put with an expiration date about a month away I look for >1% return for that month. I can often find situations where I can do much better than this, like COH and IBM recently right after earnings. See my posts in the COH thread where I think I mentioned some positions I wrote.

 

Weekly options have the highest annual percentage returns. Look at the IBM 180-strike Nov 22 expiration puts. They are bid at $0.80. (They were a lot higher earlier this morning.) If I trade at IB, I'll usually get a fill that after commissions will still result in $0.80 per share. So my return for 8 days would be 0.46%. Note if I get put to at IB there is no commission for the stock purchase so it is also a good potential limit order if you wanted IBM at $180.

 

I'm usually looking at a strike price that is at- or just out-of-the money for an expiration date that is 1-8 days away. For some longer term puts I will look at strike prices a few percent out-of-the money.

 

Boiler

 

 

 

With, say a $200k portfolio, do you feel that you could safely generate $2k per month writing naked puts and covered calls without a significant deterioration in your portfolio from commissions, taxes and market corrections?

 

I'd have to wonder what kind of damage these weekly and/or monthly options strategies would have done to portfolios in 2008 and early 2009.

 

In other words...how safe is this in a market that is sliding hard?

 

Any way to hedge against such a scenario?

[ERICOPOLY]

I'd have to wonder what kind of damage these weekly and/or monthly options strategies would have done to portfolios in 2008 and early 2009.

 

In other words...how safe is this in a market that is sliding hard?

 

Any way to hedge against such a scenario?

 

How safe is it to just buy the common stocks and not write calls?

 

The expiring option premium cushions the fall.

 

Without the option premium, you take the full brunt of the onslaught.

 

So, how did it do?  Relatively better during the fall, relatively worse during the rally (the market rallied so hard that you would have done better to not write calls).

[Lance]

Hello, I do this quite frequently, but never naked, only covered or cash secured.  Two guidelines I use are (i) I only write puts for a strike price that I'm comfortable owning the stock at and (ii) I don't sell a call at a strike price that I wouldn't be happy selling the stock at.

 

Does it always work out according to plan?  No, obviously a stock can run past or drop below the strike price, but if I would have bought or sold at that price otherwise, at least I've received a commission in addition to my sell price or purchased the shares for lower than the strike price.  I'm essentially being paid to enter a limit order.

 

There's a poster on SA named George Acs that writes some useful articles on selling covered calls.   

 

Thanks,

Lance 

[bargainman]

In my IRA I am averaging 18% per year. All I do in my iRA is write naked puts and, if put to, write covered calls.

 

 

I doubt they are naked puts.  They have to be cash covered in an IRA by law... Unless your broker is pulling something odd...  Are you sure they are naked?

[boilermaker75]

In my IRA I am averaging 18% per year. All I do in my iRA is write naked puts and, if put to, write covered calls.

 

 

I doubt they are naked puts.  They have to be cash covered in an IRA by law... Unless your broker is pulling something odd...  Are you sure they are naked?

 

Correct I meant cash-secured puts. Sometimes in my margin accounts I will do a little more than the cash I have available to get a little leverage.