Developing a Call Action Plan

Earning a consistently high yield from writing calls is not always possible, even for covered call writers. In addition to picking the right options at the right time, a covered strategy has to be structured around well-selected stocks, preferably those that have appreciated since purchase. In addition, even with the right stocks in your portfolio, you might need to wait out the market. Timing refers not only to the richness of option premiums, but also to the tendencies in the stock and in the market as a whole.

You could be able to sell a call rich in time value and profit from the combination of capital gains, dividends, and call premium. But the opportunity is not always going to be available, depending on a combination of factors:

In evaluating various strategies you could employ as a call writer, avoid the mistake of assuming that today's market conditions are permanent. Markets change constantly, resulting in unpredictable stock price levels. The ideal call write will be undertaken when the following conditions are present:


Ideal Circumstances: You own 100 shares of stock that you bought at $53 per share. Current market value is $57. You write a 55 call with five months to go until expiration that has a premium of 6. The circumstances are ideal. Striking price is 2 points higher than your basis in the stock; the call is two points in the money, so that the options premium value will be responsive to price changes in the stock; two-thirds of current option premium is time value; expiration takes place in less than six months; and the premium is $600, a rich level considering your basis in the stock. It is equal to 11.3 percent of your original stock investment, an exceptional return ($600 ÷ $5,300).

In this example, you would earn a substantial return whether the option is exercised or expires worthless. If the stock's market value falls, the $600 call premium provides significant downside protection, discounting your basis to $47 per share. A worst-case analysis shows that if the stock's market value fell to $47 per share and the option then expired worthless, the net result would be breakeven.
By Michael C. Thomsett
Michael Thomsett is a British-born American author who has written over 75 books covering investing, business and real estate topics.

Copyrighted 2020. Content published with author's permission.

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