Beware of Evidence Based on False Investment Assumptions

I have seen/read several "experts" or "pros" who quote
stats supporting the widespread use of  selling covered calls as a source of regular income who
keep quoting stats in a way that grinds me wrong.

When it comes to the stock market, pretty  much NOTHING is guaranteed.  Risk is something that can be "managed" but usually not entirely protected  against.

If you have an interest in options trading you may find this post  compelling.......if not you may want to skip ahead to another post.... Just sayin' ")

So, I just wanted to mention that when you look at a quote of a covered call premium that would potentially be paid to you if you sold a covered call at precisely that moment and had your bid honored and accepted and the order filled by your broker.... let's  call that "Premium X"

So....what I see happening is that "experts" who are hyping the advantages of selling covered calls for generating income are taking a brief premium quote and then blindly multiplying that to cover one year span of time, based on the FALSE assumption that this same scenario will exist identically on  a weekly or monthly basis ALL YEAR LONG. Then they face you with a toothpaste smile and say "See how high of a return you can earn just be repeating that pattern for one full year?" They try to entice you by showing you how, based on that one brief quote of "PremiumX" how you can double your money in 18-24months. But I want to ask you. Is that a fair assumption? Can you really take a random call option quote and multiply that by how many trading weeks/months are in the year and use that as a baseline income assumption?

Those kind of false assumptions do not take into account any kind of risk or volatility!!!

If you actually fall for that line of reasoning you are setting yourself up for huge potential losses.
Taking one random quote CAN NOT and SHOULD NOT be used a fair gauge of income generation from a covered call writing strategy. Covered Call writing can and may indeed bring in to your accounts a legitimate cash flow. But it depends on a multitude of very crucial factors.

Permit me to express some of these crucial factors:
1/ what is the current market climate for the underlying equity that you are attempting to write the covered call on ? Does that equity have an "up" season and a "down" season?
2/ Is there a consistent demand for options on that equity, or is the demand hard to predict?
3/ Companies sometimes go through extended years of negative  returns, which harshly impact any kind of positive uptrend in share pricing. How will your covered call writing be affected by a tanking stock price that  lasts more than a year?
4/ If the market for options dries up for a certain equity, are you willing to pivot and change your income strategy? Do you have enough funds to re-position and try options trading again, but with a new position on a different equity?
5/ Do you have an exit strategy if/when a trade takes an unexpected turn?
6/ What is the P/E ratio for the equity that you are writing covered calls on?
7/ Do you really understand the risks of trading options on really volatile equities with "unknown" fundamentals?
8/ Do you have other sources of income if/when you make an error of judgement? Even seasoned traders occasionally make a clerical error that can cause a loss in income. Seasoned traders know too well when their emotions have gotten the best of them and they know when it is time to walk away from trading for the rest of the day and start again on a new day.
9/ Do you have the wisdom to manage your positions on a regular basis? Selling options for consistent income requires managing your positions. One should not just "set it and forget it" if you want to protect your investments.

Markets ebb and flow. Prices of equities flow up and down and sideways. Sometimes they go bust.
Sometimes options prices are so volatile that even regular traders have a hard time following their movement and timing their trades in a consistently profitable pattern.

That  is why, it is not prudent or logical to  say that writing covered calls is Always a great idea based on the numbers gleaned from one random option premium plucked from one potential trade on one possible trading day.

There are a million different things that can affect your ability to get the price you want to collect for a covered call premium. There are also a million different  things that can happen to the underlying equity that you are writing your covered call on.

In some parts of life, blind optimism can be a great asset. Not so with financial matters. It always pays to be prepared for every possible scenario that can unfold in the markets and to be able to be flexible enough to adjust your strategy to take advantage of up markets, down markets, and sideways markets.

When something, especially in the financial world sounds too good to be true.....it just may be too good to be true. Don't just question the statistics that "experts" quote. Question how and when the statistics were collected. You can't just measure potential options trades based on one random happy sunny trading day. One also needs to prepare for those days when the clouds roll in and the profits are harder to find.

 Just take a closer look at what happened to most equity prices in the 2008 recession.  Big dips happen. Prices can take as many as 4 years or more to bounce back from a big dip. I am not trying to depress you. I am simply trying to suggest that we all need to prepare for the rainy seasons as well as for the days filled with sunshine.

In peaceful productivity,
.
C.


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I Am A Woman...I write covered calls

For those of you who are like...huh? Why does that matter that she is a woman and trades options? Well, I would vigorously retort....that You don't know where I live....and I don't mean about the technical location....I mean you don't know how women are boxed in mentally and emotionally in the social "norms" that we were raised with....in my province...in my generation.

It wasn't a "Can do" attitude....it was more of a "Can Don't" spirit. A spirit that said...."Well, yes, you are free to do and be whatever you want to be, but don't push it too far, and don't do the same things that men do....because that just won't do."

And so, when I say that I am an options trader I am speaking an earth moving life altering truth for myself.I am doing something that no other woman I know can do. Now that may speak volumes about the people I know, but it is what it is. I am open to stretching my circle to include more new and more fully developed people....people who encourage women to challenge dusty boundaries.

Now on to the subject of the day. I just want to mention a few things I am learning about
writing covered calls. Perhaps you are considering trading options and would enjoy just hearing someone chat about it.

Well, I am talking about a fairly basic "easy entry" starting point for folks who want to start trading options, called "Covered call writing".

When you "sell to open" a covered call, you are selling to another person or institution, the right, but not the obligation to buy 100 shares of your stock at a predetermined "strike" price for a period of time previously agreed upon. 100 shares equals one contract in the options world. You choose the "strike" price...which is the price at which you are willing to part with your shares. You choose the length of time that your "contract" is good for.....it can be as little as two days from now, or almost 2 years into the future. Whomever buys your covered call, has the right to buy your '1' contract for 100 shares at any point within that agreed upon time frame up until the end of the date of expiry. The person/institution who buys your call, will pay you a premium for securing that price for the shares and for the time frame that you will honor that price point. That premium that the buyer pays you either can be skimpy or it can be generous.

The cool part of selling to open covered calls is that you keep the premium you collect whether or not the covered call buyer actually "exercises" his/her/their right to purchases your shares. Somewhere I have read or heard ( but don't quote me on it) that 75% of all call options expire worthless, which would tend to suggest that just because you write a covered call, doesn't mean that you will  instantly have your call exercised and your shares sold. Call options are written as a type of "insurance" policy on securing stock prices. And  it must be noted too, that you can "cancel" your covered call option by
"buying to close" your covered call option. However, that process of buying back your call option
can be costly, especially if market conditions have propelled the stock's prices sky high.

Can anyone sell to open covered calls on the shares they own? Well, in my province, and in some brokerages, one needs to apply and get approved by the brokerage in order to be deemed "educated" enough to permit options trading on their brokerage accounts. You can check with your broker if you need their permission to trade options on your account.

So, to be fair, I am going to mention the ikky part of writing covered calls.
1/ If you don't cancel your covered call option by buying back (buying to close) your covered call
you can definitely have your shares called away. You may have owned those shares for decades and have a sentimental attachment to those shares. Therefore, if you are not willing to part with your shares, you should not write covered calls. There is ALWAYS the possibility that the call buyer will exercise his/her/their right to buy your shares at the agreed upon strike price. Therefore, you may not want to write covered calls on shares you own that you have a strong sentimental attachment to.

2/ You limit your upside gains. When you write covered calls, and the open market stock price rises astronomically on the shares you covered with a call, you will not be able to benefit from that price rise. With a covered call, you lock in your gains to be limited by the strike price you choose. That price may be near or far from the price you originally paid for those shares. Choose carefully your strike prices. Always be mindful of your original buy price.  You can "lock in " losses if you choose a strike price that is below what you originally paid for the shares.

3/ Some really cool equities do not offer options trading on them. Some of your fave stocks or reits may not give folks the opportunity to write calls on them....there is simply no options trading on them.

4/ Taxes. Be aware that options trading can have significant tax implications for you and your family. Be prepared, and know which trading accounts you can use in a tax advantaged manner to lower, limit, or prevent taxes being paid on the premiums you collect as well as the capital gains you may gain from if/when your stock is sold if a call is "assigned" (another word for when call options get exercised)

5/ Some options traders become oblivious to the risks of the underlying equity because they are enticed by juicy option premiums. But be aware that overly generous options pricing sometimes reflects high risks associated with overvalued 'speculative" stocks. These stocks may have juicy options premiums that tempt you to play their games, but they do not reveal the fundamentals which illustrate when a particular stock has poor earnings, loads of debt and an unstable financial future.
Do your diligence. When an options play seems too good to be true, it may actually reveal, upon closer scrutiny, a company that is more of a gamble, than a sound investment.

6/ Writing covered calls can incur quite hefty fees and commissions, especially if/when your call is assigned. Ask as many questions as you need to , of your broker, to find out precisely how much the fees and commissions are for writing covered calls. Use those fees as a gauge by which to help you choose which covered calls to sell. It is a cost of options trading that you always need to be mindful of.

7/ Youtube. Youtube has loads of videos available to describe in detail how to write covered calls and what to keep in mind as you  mine for profitable trades. Some brokerages offer video seminars to help you understand the process. Some brokerages also offer live seminars you can attend in person to learn more about options trading.You can also read about writing covered calls from business/investment authors such as the "Lazy Investor" Canadian Derek Foster or
"Rich Dad Poor Dad" author Robert Kiyosaki.

Well that's all for now, I haven't described everything one needs to know about covered calls, but it's been fun explaining little bits and pieces of it. Be well and prosper.

Peacefully productive,
Carla.

DISCLAIMER: This post is for discussion/conversation purposes only and is not intended as investment or financial advice. Do your due diligence and obtain qualified advice from professionals before investing. The writer/producer of this blog does not claim any liability for any of the ideas discussed in this post or any other post in this blog.







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How to Write a Covered Call

So you've decided to expand into trading options, instead of just buying or selling stocks.
One of the simplest ways to start out in the options market is through
selling covered calls. So permit me to summarize in really simple language, what the process entails to start
writing covered calls.

When you are "writing" covered calls you are actually "selling to open" a covered call.

A covered call is different than a plain ole "call option" because you actually literally own at least 100 shares of the stock that you are writing the call on.

So the first step to being able to write a covered call is by purchasing at least one hundred shares of a stock that has "options trading" available on it.

Covered calls can only be written on chunks of 100 shares at a time. One hundred shares is considered
"one contract" which you are going to write the covered call option on. There is a fee that your brokerage will charge you based on how many contracts you are going to involve in your covered call option. If you own 500 shares you could potentially write 5 contracts for covered calls.

Next you need to choose a "strike price" at which you are going to sell to open your covered call at.
The "strike price" is the price at which you give your covered call option buyer the right, but not the obligation, to buy your shares at. I suggest you pick a "strike price" that is just a little bit higher than the price that you originally paid for the shares. That is called a "near the money" covered call.
You can ask a higher premium for a covered call that is "near the money" than one that is way priced out of orbit.

You need to also choose an "expiry date" at which the call option will expire. Usually the farther into the future that the expiry date exists, the higher the premium you can ask. Once the expiry date has passed, the buyer of your call option no longer has the right to buy your shares anymore.

You are going to have to decide what price of premium you are going to ask buyers to pay for your covered call option. This premium will be estimated upon the most recent "bid and ask" prices posted for covered call options. An example of a covered call option premium might be $1.25 per contract. To discover what your earnings will be from "selling to open" a covered call sold at $1.25 for one contract, you would simply multiply the premium $1.25 by 100 and that will give you the sum of $125.00 which is the total premium that will be paid to you. Be sure to calculate and inquire of your brokerage as to what commissions and/or fees you will incur from selling to open covered calls. There will most likely be higher fees if the buyer chooses to exercise their right to buy your shares at the agreed upon strike price.

Newbie and beginner investors usually face much higher commission fees than investors with larger portfolios. The sad truth is that large portfolios usually have their commission fees waived because of the largess of their account balance. Therefore, if you are going to do an options play, and you are a small time investor, you will want to keep accurate track of all commissions/fees because they will definitely bite a significant chunk out of any profits you earn from writing covered call options.

The "premium" is the price that you are asking buyers to pay you for the privilege of  owning your covered call option. If you are not sure if you are willing to part with your shares, then you are not ready to be selling covered call options. Last I heard, there is about a 25% chance that most covered call options are actually "exercised" or "assigned". When a covered call option is "exercised" or "assigned" it means that the buyer of your covered call option is exercising their right to buy your shares at your agreed upon "per share" price.
Those who sell covered call options are prepared for the possibility that they may be forced to sell their shares. Therefore, selling covered call options are only a good idea for those who are not personally or emotionally attached to permanently owning their shares.

Well, that's about all.... those are the basics, written in my own casual language. The rest of the process is just about waiting to see if a buyer is willing to buy your covered call option, and then waiting for the deal to          "settle". Be blessed and prosperous.

C.


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