For basic description from Wikipedia, click here.
Covered calls do have its disadvantages like higher commission rate, forcing you to sell at higher tax rate for short-term capital gain, and you need to buy them back when they increase in prices beyond your strike price or lose its potential to appreciate more. Using another put costs could allow you not to lose any gain beyond the strike price. However I prefer to use my time for something more productive and insurance is not cheap. One's opinion.
My recent bad experience. I sold Netflix covered call with the strike price about 2% higher and 3% premium (from my memory) but the price shot up 12% higher in one day, so I'm potentially losing 7% profit.
It is like collecting rents from your apartment you bought. The difference is that the renter has an option to buy the apartment at a preset time and price.
Normally I prefer to sell covered options for stocks for 100 to 600 shares (i.e. 1 to 6 contracts) for the longest time (about 2-3 months). Some smaller stocks do not have a market and some stocks are not optionable. Usually high tech stocks have higher premiums to be collected. The right stocks can generate 25% or more in a year in addition to the fluctuations of the stock prices.
In general, if I feel the market will be down for the period, I use covered calls esp. for stocks over 1 year holding (unless I have short term loss to offset short term gain) or in retirement accounts. Watch out for any tax changes that may affect your total return.
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Tax law changes that affect options.
ReplyDeleteAnother area where taxpayers may get confused: Reporting stock-option sales for 2011. Those taxpayers should be extra careful, said Bruce Brumberg, editor-in-chief and co-founder of MyStockOptions.com in a recent podcast.
In stock-option transactions, the Form 1099-B you receive from your broker may underreport your cost basis, causing you to overpay taxes unless you adjust the amount, Brumberg said. That can happen because the broker likely won’t include a compensation adjustment that can serve to lower your gain (or increase your loss). In that situation, you may need to make an adjustment on Form 8949. Listen to his podcast at MyStockOptions.com.
From a fellow blogger Dr. Fred:
ReplyDeleteIt does stimulate some introspection! I write a lot of covered calls against my portfolio with pretty good results. Almost all in IRAs so tax consideration is not relevant. My rules:
1. keep the time short (weekly or one month usually)
2. check the chart and if strong uptrend go further OOM on strike
3. if this is a stock that I bought strictly as an option play, I just let the stock go. ( I've made what I hoped to already.)
4. if it is a stock that I want and it's close to the money, I will buy it back late on expiration Friday when there is no time value.
5. if the stock I want is way in the money, I let it go, and sell puts to get it back. In this last case I count the money over strike as a loss and adjust this later when I buy it back.
6. no double downs or roll outs allowed.
YTD I have made $40k with this strategy, not counting dividends, on about $400k of my portfolio. ( From the looks of things, I may be giving back some of that today.)