Advice on option writing

clancyfish · 9 May 2006

Hi,

Could someone tell me if they see anything drastically wrong with this strategy:

I'd like to write covered calls on shares I hold in NAB SGB CBA WOW & CML each month for the next 10 months. I'd make sure the strike price was slightly above what I've paid for them each time. I've never traded in puts but my undertanding is that I would then buy a put, say 10 months down the track, for my shares that would give me the right to sell them at a price fairly close to what I had paid for them in the event that any of the shares fell dramatically while at ACH. Am I missing anything? I get bamboozled by the terminology sometiimes. Does this seem a reasonable way to make a profit?

Sorry if this is too green a question.
Clancyfish.

professor_frink · 9 May 2006

hi clancyfish,

clancyfish said:
Hi,

Could someone tell me if they see anything drastically wrong with this strategy:

I'd like to write covered calls on shares I hold in NAB SGB CBA WOW & CML each month for the next 10 months. I'd make sure the strike price was slightly above what I've paid for them each time.

slightly above what you paid for each time? what do you mean by that?

clancyfish said:
I've never traded in puts but my undertanding is that I would then buy a put, say 10 months down the track, for my shares that would give me the right to sell them at a price fairly close to what I had paid for them in the event that any of the shares fell dramatically while at ACH. Am I missing anything? I get bamboozled by the terminology sometiimes. Does this seem a reasonable way to make a profit?

Sorry if this is too green a question.
Clancyfish.

bang on with the put question mate, although you'll be paying alot for a put with 10 months till expiry, you'll be able to sell the shares for whatever strike you buy. It's difficult to say if it's going to be a good strategy or not, as it will depend on what you get for your calls, what the put will cost you, etc. If you are still coming to terms with the terminology of options, where did you come up with this strategy? Or was it recommended to you by someone? My first recommendation would be to get a handle on what the terminology is before you start doing anything.

clancyfish · 9 May 2006

thanks for your response.

I meant that I would select a strike price for each contract that was slightly above what I had originally paid for the shares e.g. I paid $30.00 for NAB so would select strike price around $31.00.

I came up with the strategy through writing covered calls over the last year and on average, usually receiving about $800 premium each time. I've been burnt on BSL though by buying when it was up in the $9.00 range, writing covered call and then the price dropping by $2 or more so I guess I'm looking at avoiding that happening again.

Can you see anyway I could get burned with this?

Clancyfish

professor_frink · 9 May 2006

so your going to be exercised everytime you write a call?
Using NAB as an example, with it currently at 37.30, you sell the 31 call, receiving roughly 6.30 on the sold call, as it won't really have any time value being so deep in the money, leaving you at breakeven at best. If the stock goes up you won't make any money, and you will stay at breakeven if it falls. Sort of seems to be a bit of a waste really. The main point of selling a covered call is to sell an option with as much time value as possible. If you were to sell the 38 may call, you'd get at least 40 cents for it, and if the stock doesn't go above 38 before the 25th, you'd keep all the premium and make some additional profit on your shares. If you do sell a deep in the money call, you probably won't need to buy the put with 10 months till expiry.

professor_frink · 9 May 2006

The main risk in a covered call writing strategy is basically what you've described above with BSL, where the premium you receive for the call doesn't make up for the share price losing a large chunk of its value. By buying a put you are helping to offset this to a certain degree, but it's still far from perfect.

Using NAB as an example, if you bought the stock today and then sold the ATM call(37.50) against it, you'd receive about 55 cents. If you do this for 10 months, you could collect up to $5.50 in option premium(less 10 lots of brokerage) over that time.

Now lets say you spent 30 cents on march 2007 puts with a strike of 30, you would be protected from a crash, but if the stock went into a slow and steady decline, then you could be faced with the situation where in 10 months time, the stock has lost enough value to take away the profit on your covered calls, but hasn't moved down far enough, or fast enough for your put to increase in value much. The only way to make that situation better is to buy a put that is closer to the money, but the closer to the money you buy, the more it will affect the profitability of the overall strategy.

Not saying that it's a bad strategy or anything like that, but there still is a potential downside to it, but then again, there is a big downside to almost any options strategy if it goes badly.
Hope this helps a bit

money tree · 9 May 2006

I think you are trying to have your cake and eat it too.

Instead of being long the FPO and hedging it with a put, why not just buy a long dated itm call and write short dated atm calls against it?

Your downside is protected mostly (probably as well as the put considering time decay) and risk-margin is covered.

pros - less risk, far less capital
cons - no divs

wayneL · 9 May 2006

money tree said:
I think you are trying to have your cake and eat it too.

Instead of being long the FPO and hedging it with a put, why not just buy a long dated itm call and write short dated atm calls against it?

Your downside is protected mostly (probably as well as the put considering time decay) and risk-margin is covered.

pros - less risk, far less capital
cons - no divs

Exactly!

Always look for the synthetic equivalent

clancyfish · 9 May 2006

thanks for all your advice. I've been having a lot of success in writing covered calls and buying options for the last year. What does the forum think of rather than using an online broker, now using an accredited options broker for the more complicated strategy. I guess, using someone to walk me through it for a while. I know brokerage fews are a lot higher but tapping into someone else's experience and knowhow would be worth it. What do you all think?
Clancyfish

clancyfish · 9 May 2006

Just to add to above, I'm talking about using Moneytree's strategy.
Clancyfish

money tree · 9 May 2006

Avcol broking I find gives full service for discount price. They are quite happy to help if you tell them you are green.

robots · 9 May 2006

hello

by money tree:

"Instead of being long the FPO and hedging it with a put, why not just buy a long dated itm call and write short dated atm calls against it?

Your downside is protected mostly (probably as well as the put considering time decay) and risk-margin is covered.

pros - less risk, far less capital
cons - no divs"

dont understand this,

a) so your buying a call (long dated) with strike price less than share price with premium X

b) and your selling a call (short dated) with a strike price equal to share price for premium Y

in step a) the strike price and premium X "typically" equal current share price depending on market sentiment,

in step b) the same

you will profit on bought call and other person will profit on sold call

premiums will move accordingly on share movement

so what are you looking for?

thankyou
robots

money tree · 9 May 2006

a call with 6 months to go may be worth 100c. however, a call with ONE month left may be worth 25c. Also, an itm call has small amount of time premium. An atm call is ENTIRELY time premium.

day one:

buy 6 month call @ 100
sell 1 month call @ 25
net = -75

month one:

sell 1 month call @ 25
net = -50

month two:

sell 1 month call @ 25
net = -25

month 3:

sell 1 month call @ 25
net = 0

month 4:

sell 1 month call @ 25
net = +25

month 5:

sell 1 month call @ 25
net = +50

NettAssets · 9 May 2006

There is also the possibility of writing more than one current dated calls in the one month.

Don't hesitate to buy back the calls if there is a sudden dip in the option premium from a share price slip or a volatility movement. Then sell them again a day or two later.

WES this month (or rather this period) is a classic example.
May 38.50 calls have moved from 51c on 24/4 to 1c
tonight
still 16 days to go so why not try and repeat maybe on a lower strike call.

Hopefully WES wont still be down here when my long 35.50's expire.
Regards
John

robots · 13 May 2006

hello,

would love to see someone start a topic a la "EX dividend is there a connection" regarding option writing/stradegies

there's plenty who talk about option stradegies

i personally only believe they (options) are good for people/funds for "insurance"

lets see some of these stradegies in action, posts can be after hours, transparency is the key

thankyou
robots

wayneL · 13 May 2006

robots said:
i personally only believe they (options) are good for people/funds for "insurance"

Then for you, that is most certainly true.

Advice on option writing

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