Covered Call Writing Using The Buy Write Strategy
The buy write covered call is a slightly different strategy from the over write strategy, although the mechanics are identical in terms of outcome and follow on actions. The difference is in the strike price you choose and the period. In a previous article using the over write strategy, we looked at an example using British Airways, a UK share, but one which only had quarterly options available. There are some heavily traded UK equity options which are available monthly, but most UK options tend to be quarterly as the market is much smaller.
In the US, because the market is enormous, most stock will have monthly options and therefore I find this strategy lends itself better to the US markets. The stocks you are looking for are those that are trending sideways. Remember the idea with all call writing is to find a stock that you can write an option on which will then expire worthless, allowing you to repeat the exercise. You do not want shares or stocks that are shooting skywards!!!! - when you are looking at your charts look for shares that are moving in channels sideways, perhaps have hit some resistance - we do not want highly volatile stocks either ( you will need to become familiar with volatility - both historic and implied ) -the whole point of the strategy is NOT to be exercised. When you become more familiar with these things you will see that volatility and premium price are intertwined. It is obvious when you think about it - if a share moves violently all over the place it has a much higher chance of achieving the strike price and therefore will have a higher premium. This is particularly true on the US market - in the UK it is not so bad as those quoted are mainly FTSE 100. Please be careful, there are some real horrors. I would strongly suggest that you stay away from those in the pharmaceutical sector for example, as a new drug or a drug withdrawn can have dramatic effects on the stock price.
So, we are looking for stocks with relatively low volatility, and preferably in the top 500 -1000 US companies by market capitalisation. They should be moving sideways on the charts in a channel in a neutral to slightly bullish trend ( after all you don't want to be buying a stock that you should be shorting!! ). Having identified possible candidates you then check their option series and look for the next month and the next available strike price out of the money. Lets take Dell computers as an example. Share price : June 21st Dell $24.08, - July Call Option :Strike Price : $25.00, Call Option : $ 0.40
We would therefore buy 100 Dell shares at 24.08 and at the same time write a call option with a strike price at 25.00. giving us a premium of $40. If the share price increases and we are exercised we have a profit of 0.92 x 100 + 0.40 x 100 = $132 for the month. If the share price does not increase but remains the same or falls, the premium may offset some of the decline in price, and we can then write another call. The ideal of course is that the price closes close to the strike price, so we keep the premium and the shares, and then write another option at $25 which would have a much higher premium as the share price would then be 'almost in the money' which would give a much higher premium.
There are many ways to use this trading technique, but you also need to understand the Greeks, and implied/historic volatility in order to analyse the value of the premium that you are considering. Once you have started writing covered calls on a regular basis, you will discover numerous reasons why you might want to close or modify a position before expiry.. There are a whole variety of techniques that allow you to 'roll' positions forward, to take advantage of situations that may arise during the course of a contract.
In the US, because the market is enormous, most stock will have monthly options and therefore I find this strategy lends itself better to the US markets. The stocks you are looking for are those that are trending sideways. Remember the idea with all call writing is to find a stock that you can write an option on which will then expire worthless, allowing you to repeat the exercise. You do not want shares or stocks that are shooting skywards!!!! - when you are looking at your charts look for shares that are moving in channels sideways, perhaps have hit some resistance - we do not want highly volatile stocks either ( you will need to become familiar with volatility - both historic and implied ) -the whole point of the strategy is NOT to be exercised. When you become more familiar with these things you will see that volatility and premium price are intertwined. It is obvious when you think about it - if a share moves violently all over the place it has a much higher chance of achieving the strike price and therefore will have a higher premium. This is particularly true on the US market - in the UK it is not so bad as those quoted are mainly FTSE 100. Please be careful, there are some real horrors. I would strongly suggest that you stay away from those in the pharmaceutical sector for example, as a new drug or a drug withdrawn can have dramatic effects on the stock price.
So, we are looking for stocks with relatively low volatility, and preferably in the top 500 -1000 US companies by market capitalisation. They should be moving sideways on the charts in a channel in a neutral to slightly bullish trend ( after all you don't want to be buying a stock that you should be shorting!! ). Having identified possible candidates you then check their option series and look for the next month and the next available strike price out of the money. Lets take Dell computers as an example. Share price : June 21st Dell $24.08, - July Call Option :Strike Price : $25.00, Call Option : $ 0.40
We would therefore buy 100 Dell shares at 24.08 and at the same time write a call option with a strike price at 25.00. giving us a premium of $40. If the share price increases and we are exercised we have a profit of 0.92 x 100 + 0.40 x 100 = $132 for the month. If the share price does not increase but remains the same or falls, the premium may offset some of the decline in price, and we can then write another call. The ideal of course is that the price closes close to the strike price, so we keep the premium and the shares, and then write another option at $25 which would have a much higher premium as the share price would then be 'almost in the money' which would give a much higher premium.
There are many ways to use this trading technique, but you also need to understand the Greeks, and implied/historic volatility in order to analyse the value of the premium that you are considering. Once you have started writing covered calls on a regular basis, you will discover numerous reasons why you might want to close or modify a position before expiry.. There are a whole variety of techniques that allow you to 'roll' positions forward, to take advantage of situations that may arise during the course of a contract.
