Monday, January 9, 2012

A Look At Covered Calls - Jan 9 update

This is an update of my A Look at Covered Calls - The Naked Truth project. A hypothetical portfolio of systematic covered call writing (AKA synthetic naked put writing).


FCX has been lingering around the $39 mark for a few days now. The Jan $37 calls have about 30c of extrinsic, whereas the ATM $39 Jan calls have around $1.00 of extrinsic.

The question is whether to pick up another 70c of extrinsic while losing the $2.00 of intrinsic hedge we have at the moment. I say stuff it, let's do it, we're all about premium collection here and damn the downside risk. :-P

I'm buying back the $37 calls at the offer of $2.52, a loss of 20c, and selling the Jan $39 for $1.17 with FCX trading at $39.21. So we're $1.89 to the good with the covered calls while just holding the stock would have us $2.09 in profit at this stage.

No action on NOV and GS.


  1. The Premium the Covered Call writer collects is what makes Covered Call investing very profitable over time. For instance, if you can write Covered Calls monthly and generate an average 10% monthly profit from the combination of the premium plus any additional profit you receive from being called out, you'll make a 120% yearly return on your investment (213% compounded)! This is much higher than any mutual fund returns. Mathematically, a $3,000 initial investment can balloon to $1,000,000 in just over 5 years if you average 10% monthly returns and don't add any more to your original $3,000 principal investment (other than reinvesting the 10% monthly profits).

  2. 10% per month. Therein lies the rub. Collecting 10% premium on an ~30 day time frame means selecting buy/writes with very high native volatility or stock in periods of very high IV for whatever reason. One would assume movement in the underlying to more or less reflect IV in the time frame selected.

    Assuming you wrote ATM, there is approximately 50% probability that movement is to the downside, gaining deltas as you go. Ergo some of those buy/writes will not be overall profitable to the tune of 10% at all including some substantial losses.

    This is what I'm doing here. It's not a perfect example, but over time it will show the vagarities of the covered call strategy and that talk of x% per month compounded as largely nonsense.