Posts Tagged ‘covered call’
by Chris McKhann
Every trade has a life cycle, but some are longer than others. I think of Warren Buffett saying that his preferred holding period is forever. Options, of course, are a decaying asset, so their life cycle is much more clearly defined.
The good options trade is born out of research. That research likely includes fundamental and technical analysis. Because options are shorter term by nature, most traders of them focus on technical analysis.
Research into an options trade should also include looking at volatility data. The implied (A measure of the volatility of the underlying stock. It is determined by using option prices currently in the market.) and historical volatility (The realized volatility over a specified period. It is calculated by determining the average deviation from the average price in the timeframe.) are vital ingredients to judge the probability of a trade ending profitably.
Some trades have their origination in the trader’s own research. Others come from advisors or newsletters. Still others come from specialized options tools, such as tradeMONSTER’s StrategySeek. Regardless, the life of an options trade should begin not with trade execution but with research (see fig.1)
A RECENT TRADE
An example of how an options trade can be adjusted as it evolves is key to understanding the process. On Jan. 8, I bought 10 puts of the SPY S&P 500 SPDR Exchange Traded Fund for $4.80. With SPY above $114—a new high since the crash in September 2008—and the Volatility Index below 19, I felt that some downside protection made sense.
VIX is a measure of the implied volatility of the S&P 500 Index options and thus gives a good proxy for the relative value of those options.
This put buying could be viewed as a hedge against a portfolio of stocks, a holding in SPY itself or just as a bearish play, regardless of whether I was long any stock.
I bought the June options to reduce the time decay that increases exponentially as the options approach expiration. I figured I might want to hold this put for three to four months, so I bought six months out.
ALWAYS KNOW YOUR EXIT
I also had my exit in mind when I entered the trade. I would exit the puts if they lost half of their value, trading down to $2.40. I also had a time stop, as I knew that I did not want to hold the puts during the last month before expiration.
By Jan. 22, SPY had dropped below…
$110, following two sharp days of declines, and VIX had popped up to 28.
I had to make a decision. I could sell my puts for a profit, but I was not sure if the declines were over. I was also not in the position to just make a quick buck. If that had been my intent, then a nearer expiration would have made more money.
BACK TO THE BOOKS
So I returned to do more research. I wanted to take advantage of the pop in volatility, which had the greatest effect on the nearer-term options. I checked StrategySeek, tested some alternatives and decided to sell the March $110 puts against the June puts that I owned as a calendar spread.
I sold the March puts for $3.95. Now my timing was not the best in terms of the decline. SPY traded all the way down to $105, and VIX spiked again but did not rise much higher than where I had sold.
End of Part 1
To be continue…
by MDM Partners
Before the bell store operator Macy’s is trading lower at $23.45 or down 1.8% since yesterday close despite the company said it will register profit for the first three months. MDM Partners is expecting the price to fluctuate in the range of $22-$26 and we are going to make a covered call for this stock – May call with strike $22.00.
Department store operator Macy’s Inc. (M) on Wednesday said it swung to a fiscal first-quarter profit of $23 million, or 5 cents a share, from a loss of $88 million, or 21 cents, a year earlier. Sales in the quarter ended May 1 rose to $5.57 billion from $5.2 billion. The company said the most recent quarterly result included $27 million in premium and fees related to debt repurchase. Analysts, on average, estimated the company to earn 4.6 cents a share on sales of $5.54 billion, according to Thomson Reuters. Macy’s said it’s “premature” to raise annual profit forecast further at this time given the macro-economic uncertainty. It had already increased its full-year outlook in late April.
See later our update on Macy’s…