One of my goals for 2105 was to learn about options. And so I did. The best way to learn is to trade them, at least, that is how I look at it. Since June 2015 I trade options, more precise, I sell option premium.
Not all trades go as expected. In order to capitalise on my learning, I document some interesting trades on my blog.
In order to boost my dividend income of my positions, I sell covered calls on my stock. For now, I do this only on my play money.
Early October, I looked at my portfolio and noticed a stock that was available for a covered call. around that time, I thought it was a good idea to have always a covered call on all my shares. If things would not go my way, I would roll the position, just as I roll puts.
The learning trade
The graph below tells the story. On Oct 1st, I write a covered call with a strike of 23,5. The expiry date is November 20.
In a few days time, the price goes up to 24, 5. At this time, the option is In The Money. If it stays here, I will need to sell the stock at a price of 23,5. When you write a contract, you know this…
Here is the problem: I did not really want to sell the stock at 23,5. This was too close to my initial average purchase price for that stock. Not that I am greedy – well maybe, it is my play portfolio.
Secondly, this stock is part of my play money portfolio, where I wanted to experiment with dividend stocks and options. Loosing the stock before I get to experiment with dividends and options during an extended period of time did not make sense too me.
IT could be called away. There is always the risk that someone exercises the option just before the dividend date to get the stock at a discount and get the dividend as a bonus. (There are some ways to calculate this, it has to do with the extrinsic value of the option compared to the dividend).
Why not roll?
I looked at rolling the position a few times, and discovered that it is not as easy as puts. This is most likely due to the option skew. In short: there is more premium in puts than in calls as stock tend to fall harder and faster than that they go up. As a result, I needed to go out way too far in time to be able to roll the call to a higher level.
After about 3 weeks I made a tough call: I bought back the option with an important loss. You can see the loss in my 2015 evaluation.
The loss of about 71 euro is not nice, but if you consider that this is the price to pay to get good insights in covered call, than this is a bargain.
The lessons learned
Hence, I refreshed the rules for my covered calls, the hard way (often works best)
- It needs to be a price that gives a good (approx 5pct) gain on the stock. This can either be the average buy price, or one of the entry points for that stock.
- Make sure the expiration date is far enough away from an ex dividend date. Ideally, about 30 days or so.
- Recently added due to the Belgian speculation tax: if the last buy of the stock is less than 6 months: make sure the strike is longer than the 6 month.
What are your rules for covered calls?