By Don Fanstone, Member, Kitchener/Waterloo User Group
Selling Covered Calls can often create a great deal of angst when the underlying stock goes up in price and the Call option goes up in price in tandem. The seller of the Covered Call feels that they’re “missing out” on the stock price increase. They may have made a wrong decision by selling the Covered Call, but rebuying the Call Option prior to expiry soon eats up any gains due to trading expenses and the increased cost of rebuying the Covered Call.
When a decision has been made to sell a Covered Call, it’s best to let the trade expire without buying the call option back before the date of expiry.
When selling Covered Calls for Income, sell one month out and one strike out of the money, preferably on a stock with high volatility. The higher the volatility the higher the Option Premium.
With the market being “beaten down”, there are a number of quality stocks that offer attractive one month returns.
e.g. Linamar – Current Price $70.33
A November $72 Call Option can be sold for $2.70. If not called by the third Thursday in November, the return is 3.83% Annualized 46%
If called; the return is $2.70 (Option Premium) plus $1.67 (Difference between Stock Price and Strike Price) for a return of $4.37 or 6.22%. Annualized 74.5%.
Linamar reports earnings approximately Nov. 5th. A choice to sell now or wait on a possible favourable earnings report.
If a Covered Call is sold now, it protects on the downside, but may limit the potential upside of a good earnings report. (A bird in the hand is worth two in the bush!)
The ideal time to sell covered calls is when the DPO is at a high. (11/11/2014, 02/13/2015/ and 06/03/2015)
Gold and Mining shares are offering very high volatilities and attractive Covered Call returns. See ABX, ELD, FM, TCK.B.
DISCLAIMER: Options trading involves risk and is not suitable for everyone. The information contained in this Blog is for education and information purposes only. Example trades should not be considered as recommendations. Options training is strongly recommended before placing any trades. VectorVest offers a basic options course online and occasional intermediate options workshops in Canada each year.