Now that you have your stock list narrowed down to your high dividend achievers that you hold in your portfolio, you now need to do some research and determine which guy in your fold is best for you to write covered call options against.The answer: the one that will make the worst call option write.In some respects this sounds like we might be dooming ourselves to failure since it would follow that the underlying stock that is the worst call option choice might also be a terrible underlying stock whose price could plummet faster than the Titanic just before Jack had Rose climb over the back guard rail.But, it’s all relative.At this point you should have selected a stock that has good dividend and stock fundamentals (there are numerous blogs here on dividends and fundamental analysis.For an index, go to www.myhappyassets.com, click on assets and then dividends).So, it is a moot point and we are merely comparing which is the worst call among the bunch or conversely, which is the best call write?
1. How Much is that Option in the Window?
First, how much can we get for the option?You are going to have to look up the option chain for your underlying dividend yielder and just as a precautionary note, some might not have an option chain, it is not a given.To find this, go to your local mutual fund provider’s (mine is Fidelity but Morningstar is a good one) research/options page and enter in your ticker.Up should pop something like this below:
Now, I’m going to assume you are somewhat familiar with what is going on above.The expiration and strike is the day the option expires and the price it must reach to be “At the Money.”If the stock – ICG – was currently trading at $40 then the –ICFBI $35 call would be $5 in the money.Here’s a hint: as a covered call writer we don’t want to sell anything that is in the money.Next we see the bid and ask price which is something very important to us since it determines how much we are going to get paid.Traditionally, you can subtract the bid from the ask, divide by 2 and this back to the bid to get the premium you should receive for selling the option.So for the –ICFBI call, we should expect $5.45 in premium.Now, an options contract is for 100 shares so you would receive $545 – not bad but this call is in the money so we are going to want to move on down the options chain say to the $42 call options where we can receive decent money while being out of the money.
Next, we want to move on to Technical Analysis.I have also written some blogs here on Options rules.Please go to www.myhappyassets.com, click on assets and options to find these blogs.
In order to perform a first-wave technical analysis on your stock you are going to need to be familiar with basic chart patterns; support and resistance levels, double tops, triple tops, double bottoms, triple bottoms, head and shoulders, reverse head and shoulders, triangles, wedges, pennants so on and so forth.I don’t have time to create the charts here but I recommend you check out some great options books such as
And
in order to get familiar with the basic chart patterns.Once you have done this (or if you already are) take a look at your underlying security’s chart and make note of any patterns you see for the one year, 6 month, 3 month and 1 month.Is it bullish or bearish?Particularly, what is the sentiment for the duration of your covered call write?If your call write expires in a month, is it bearish in the short term?If it expires in three months, is the stock bullish or bearish for this time period?You will not necessarily know your stock’s time frame at this point but keep these things in mind and circle back if necessary.
3.The Experts Say …
At Fidelity.com I can go to a technical analysis area of the underlying security and I can see all the price movement indicators, from oscillators to stochastic to gesundtights that are automatically generated by the marvelous wonders of the internet combined with PC computing power.This saves a lot of time and extends the life of my slide rule.I am sure in today’s day and age that you have some automated, technical analysis expert spiel at your local, friendly, on-line mutual fund broker.This is what Fidelity looks like for another stock, PDS:
Technical Events™ from Recognia™
Click an event name to learn more about it. To search for more stocks with recent chart patterns and Technical Events™, start anAdvanced Search.
I get an outlook for short-term, intermediate and long-term.Now, do I know what a hammer short term pattern is?No, but it is bullish and I can click on the term and discover that “The Hammer indicates that the prior downtrend is about to end and may reverse to an uptrend or move sideways. This pattern is an indication of a financial instrument's SHORT-TERM outlook.”
Now, are all indicators created equal?Certainly not, some are more-so than others.I would say the traditional patterns, support and resistance, tops and bottoms, triangles and wedges and price crossing moving average are more important than others, so don’t weigh all equally and make sure you take some time here to educate yourself on chart patterns and technical analysis.In the end, what are the experts saying here.Are we bullish or bearish for the term we are looking at?We should be developing a picture if our underlying security is going to make a good call write that will not be called away.In other words, it is going to make a bad call option.
4. My Big Fat Greek Option
What is the implied volatility of the underlying option?To find out the “Why” and “How”, go to www.myhappyassets.com, click on assets, options and then “Some Basic Rules about Option Trading.”This will give you the low-down on implied volatility and why it is important to us in our covered call writing business.Based on this level you should be able to add another piece to the puzzle as to why this stock would make a good call write or not.
What are the Greeks saying?
If you are not familiar with option Greeks, get familiar with them.I will go over them briefly here:
Delta – in high-level, lamens terms, this is the likelihood an option will finish in the money.Thus, for us, we want to see a low probability here.
Book definition: the amount by which an option's price will change for a one-point change in price by the underlying entity.
Book example: A delta of 0.50 means that for a $1 change in the underlying, the call/put option would rise/fall by $0.50.
Theta – this measures how much of an option’s value is lost due to time decay.
Book definition: the rate of change in an option's theoretical value for a one-day change to the option's expiration date. Theta quantifies time decay, which describes how the theoretical value of an option erodes or reduces with the passage of time.
Book example: A theta of 0.07 means that for every one-unit change in time to expiration, the call/put option would rise/fall by $0.07.
A theta of 0.07 means that for every one-unit change in time to expiration, the call/put option would rise/fall by $0.07.
Gamma
Book definition: the rate of change in an option's delta for a one-point change in the price of the underlying security.
Book example: A gamma of 0.051 means that for every $1 change in the underlying, the delta would rise/fall by $0.051.
Vega
Book definition: the rate of change in an option's theoretical value for a one-percent change in volatility.
Book example:A Vega of 0.10 means that for a 1% change in volatility, the call option would rise/fall by $0.10.
Honestly the Greeks play a bigger part on the other side of the coin, for the options buyer since they should be used for the trader to help adjust his position as time marches on and the underlying value changes.But, we should not ignore them and use them to judge what to do next with our covered call write.Remember, you do have options here (no pun intended).At option can expire worthless at which case we get to keep the premium and the underlying security and are free to go on our merry way and write another option.But, should the price increase and we want to close out early, we can by issuing a buy to close thus closing out the position before it is closed.We can also buy at close if the stock ends in the money and we do not want our stock called away.
Become familiar with the Greeks and use them to determine what adjustments you need to make throughout the lifetime of your call write.Also, you must develop an option plan: when will you enter, when will you exit and you need to either set a stop loss order, an alert or at least a mental alert.Go to www.myhappyassets.com, click on assets, options and read up on the rules.
Remember, Delta is the likelihood this guy is going to end up in the money so lean towards this fellow.
5. Other Options (again, no pun intended)
You might have further “auto-web” research options available to you.I know Fidelity.com offers an evaluator for a buy-write but it is important to not get turned around here.A lot of evaluators will treat it just as that, a buy-write and evaluate the underlying stock which for us, for this model, is a moot point since we own the stock for its fundamental analysis and its dividend income.You might also have some further evaluating metrics and reports available at Morningstar.
In the end, you need to run the preceding for each of your dividend stocks you hold at least 100 shares of and determine which is going to be the best covered call write for you.For me, honestly my first covered call write came down to a mix of the underlying likelihood it would finish out of the money and the premium I would receive.It became obvious after looking at the options chain that only one had enough volume to deliver decent income and coupled with the underlying analysis that it would not likely be called away, it was clear which of my securities would make the best covered call write.
Make sure you spend plenty of time on your education before dipping your toe into options even the conservative strategy of covered call writes.I estimate that I spent about 3 months reading, paper trading and getting a really good feel for the strategy even though I admit, I’m still no expert.There is something to be said for taking action and although I believe in “getting educated” I also hazard you to be aware of analysis paralysis.At some point you just have to pull the trigger.
Good luck, and remember, if you need and index to other topics posted here, go to www.myhappyassets.com and click on assets.Coupled with your high dividend yielders you should be able to generate approximately $1000 in monthly passive income - $500 in dividends, $500 in covered call options but remember, if you spend 40 hours researching and monitoring, is it truly passive?This is something you will have to evaluate for yourself as you get leaner and streamlined.After you get it down pat and you have a system in place it should really take you no more than a few hours per month and thus in my opinion, it would truly be passive income.
Posts
No comments:
Post a Comment