Advanced Defensive Covered Call Techniques

The following information is detailed in Hooper and Zalewski's book, Covered Calls and Leaps.

Debit Spread: selling a call option while using another long call for cover rather than the stock.

Surrogate Stock Replacement (SSR)

This expedites the profitable close-out of a covered call transaction where the following three details apply:

1. An investor has used the TSS on the position.
2. The stock has continued to move up after selling the TSS for income and now the investor cannot buy back the TSS for income call due to this buyback being unprofitable.
3. The investor now has a profit in the stock position but is prevented from closing the entire transaction because it will result in an overall loss.

In the case where the TSS is failing (the stock is still going up), an investor can:

1. Wait longer to see if the price erodes and lead to a profitable buyback of the call.
2. Wait for a large increase in the stock price and close on the delta effect. (stock price increases greater than the option buyback price.)

Implementing the SSR

In using the SSR, the objective is to restructure the position through the following three actions:

1. Close out the existing position by buying back the call and selling the stock. This will result in a temporary loss.
2. Purchase a LEAP or in other words, a longer-term call in place of the stock.
3. Sell a near month or two month out call that will provide a positive called return on the entire transaction.

LEAPS - option contracts with one year or more to expiration and a January 200x expiration.

There are 10 rules for using the SSR. I will cover these in the next posting. For now, here is a preview of the CPR technique again, as detailed in Hooper and Zalewski's book Covered Calls and Leaps.

CPR (Cardiopulmonary Resuscitation)

There are two applications for the CPR:

1. To dramatically expedited the closing of a new covered call position where the stock price has suffered an immediate decline after entering the transaction. The CPR provides this ability as in many cases it allows the investor to lower the strike price of the short call in the near month yet continue to maintain a positive called return.
2. To generate income and reduce the cost basis in a deeply depressed position. The CPR can effectively be applied where an under-performing stock is now in an upward cycle but the cycle's depth is too shallow to effectively use the TSS for income.