New Insights on Covered Call Writing The Powerful Technique That Enhances Return and Lowers Risk in Stock Investing

by Lehman, Richard; McMillan, Lawrence G.

• ISBN13: 9781576601334
• ISBN10: 1576601331
• Edition: 1st
• Format: Hardcover
• Copyright: 2003-05-01
• Publisher: Bloomberg Press

Summary

Does this sound like you? You want the long-term returns from stocks but don't like the volatility. You like the security of income from bonds and CDs, but the yields are too low. You wish there was a sensible discipline you could follow that would provide the attractive returns offered by common stock yet with more consistency and less risk.If so, then covered call writing may be the investment strategy you've been looking for.You can achieve long-term returns commensurate with stock market returns but with lower volatility and less downside risk. The trick is to combine stocks with call options by "writing" a call against a stock you already own. Professional investment managers have been using this strategy for years, and recent developments have now made it easier for individual investors to employ it as well. Options experts Richard Lehman and Lawrence McMillan unlock the secrets of covered call writing in this groundbreaking, easy-to-understand guide.

Author Biography

Richard Lehman has more than twenty-five years of experience applying his expertise in options strategies. He has held executive positions at E. F. Hutton, Thomson McKinnon Securities, First Saxonia Securities, and at the New York Stock Exchange. As an independent adviser, he now runs an online advisory service Lawrence G. McMillan is recognized as one of the foremost options trading experts. He has written three best-selling books on options, As president of McMillan Analysis Corporation, he writes the "Daily Volume Alerts" and edits and publishes The Option Strategist

Table of Contents

Acknowledgments	xiii
Preface	xv
Introduction	1	(6)
Part I BUILDING THE FOUNDATION
Option Basics	7	(16)
What Are Options?	8	(1)
How Options Compare with Stock	9	(3)
Standardization	10	(1)
Listed versus Unlisted	11	(1)
Option Listings	12	(2)
Strike Price	12	(1)
Expiration	13	(1)
Players and Positions	14	(1)
Exercise and Assignment	15	(4)
The Basic Mechanics	15	(3)
What Happens at Expiration	18	(1)
Covered versus Naked	19	(1)
Options in Your Account	20	(1)
Recapping Option Basics	21	(2)
Just Beyond the Basics	23	(18)
Valuing Options	23	(6)
Fair, or Theoretical, Value	23	(2)
Volatility	25	(1)
Interest Rates	26	(1)
Dividends	27	(1)
Theory versus Reality	27	(2)
Trading Symbols	29	(5)
Adjustments	31	(1)
Expiration Months	32	(2)
How Options Are Traded	34	(5)
The Exchanges	34	(3)
Computerized Quotes	37	(1)
Liquidity	38	(1)
Recapping Just Beyond the Basics	39	(2)
Covered Writing Mechanics	41	(18)
Requirements for ``Valid'' Covered Writes	42	(1)
Risk/Reward of a Covered Write	43	(9)
Risk/Reward Characteristics Over Time	45	(2)
Risk Transference	47	(1)
Shorting a Call versus Shorting a Stock	48	(1)
More on Exercise and Assignment	49	(3)
Calculating Potential Returns	52	(7)
Return if Exercised (RIE)	52	(1)
Return Unchanged	53	(1)
Return Based on Net Debit	54	(5)
Part II EXECUTING THE STRATEGY
Turning a Position Into a Strategy	59	(24)
A New Way of Thinking	60	(1)
Follow-up Actions	60	(11)
The Simple Case: Doing Nothing until Expiration	60	(2)
Closing Part or All of the Position	62	(1)
Rolling Options	63	(2)
Rolling Up	65	(2)
Rolling Up and Out	67	(1)
Rolling Down	68	(1)
Rolling Out	69	(1)
Other Considerations	70	(1)
Covered Call Strategies	71	(12)
The Total Return, or ``Buy-Write,'' Approach	72	(2)
The Incremental Approach	74	(4)
Hedging Individual Stocks	78	(1)
Reducing Risk in Small Portfolios	79	(1)
Writing Calls on ``Hot'' Stocks	79	(2)
Tax Deferral Strategies	81	(2)
The Benefits of Covered Writing	83	(24)
The Rationale Behind Covered Writing	84	(1)
Realistic Expectations	84	(1)
Call Writing and Stock Returns	85	(3)
Major Factors Affecting Call Writing Returns	88	(9)
Stock Selection	88	(1)
Strike Price	89	(1)
Expiration	90	(2)
Volatility	92	(3)
Interest Rates	95	(1)
Transaction Costs	95	(2)
Covered Writes Compared with Stocks Over Time	97	(8)
The BuyWrite Index (BXM)	97	(2)
Real-World Results for Twenty Stocks	99	(4)
Results by Calendar Year	103	(1)
Effects of Writing a Higher Strike Price	103	(2)
Recapping Benefits	105	(2)
Intangible Benefits	107	(12)
What is Long Term, Anyway?	107	(1)
The Covered-Write Solution	108	(2)
The Benefits in Detail	110	(9)
Implementation	119	(32)
Deciding on Your Approach	119	(6)
Incremental Writing	120	(1)
Traps Involved in Writing for Incremental Return	120	(2)
The Total-Return Approach	122	(1)
Traps in the Total-Return Approach	123	(2)
Are You a Fundamentalist or a Technician?	125	(1)
Selecting Stock Positions	126	(5)
Searching All Stocks	127	(2)
Searching Specifically for Covered Writes	129	(2)
Selecting Calls to Write	131	(4)
Which Strike Price?	131	(2)
Which Expiration Month?	133	(2)
Getting Your Ducks in a Row with Your Brokerage	135	(5)
Full-Service versus Discount Brokers	135	(2)
Online Brokers	137	(1)
Financial Planners	137	(1)
Which Account to Use?	138	(1)
Writing Calls on Your Employer's Stock	139	(1)
Keeping Records	139	(1)
Placing Orders	140	(4)
Market and Limit Orders	140	(2)
Stop Orders	142	(1)
Buy-Write Orders	142	(1)
Using Spread Orders When Rolling	143	(1)
Risks	144	(1)
Basic Tax Rules for Options	145	(4)
Precepts for Covered Call Writers	149	(2)
Advanced Implementations	151	(28)
Covered Writing on Margin	151	(4)
Margin Rules for Covered Writes	152	(2)
Advantages of a Margined Covered Write	154	(1)
Covered Writing against Securities Other than Stock	155	(7)
Covered Writing on ``Diamonds,'' ``Qs,'' and Other ETFs	155	(1)
Writing Calls against Convertible Securities	156	(2)
Writing Calls against Other Options---The ``Call-on-Call'' Covered Write	158	(3)
Covered Writing on LEAPS	161	(1)
Partial Writing, Mixed Writing, and Ratio Writing	162	(5)
Partial Writing	163	(1)
Mixed Writing	164	(1)
Ratio Writing	165	(2)
Put Writing	167	(2)
Advantages of Put Writing	168	(1)
Disadvantages of Put Writing	169	(1)
Implied Volatility and Overvaluations	169	(6)
Efficiency, Inefficiency, and Overvaluation	170	(5)
Expiration Games	175	(1)
Option-Stock Arbitrage	176	(3)
Tools for Covered Writers	179	(14)
Option Chains	180	(2)
Search Tools	182	(1)
Calculators	183	(5)
Probability Analysis	184	(4)
Industrial Strength Option Software	188	(1)
What Will This Cost You?	189	(1)
Internet Resources for Covered Call Writers	190	(3)
Afterword	193	(7)
Appendix A: Timeline of Options Trading in the United States	200	(2)
Appendix B: Sample Covered Writing Spreadsheet for Tax Purposes	202	(1)
Appendix C: Tax Rules for ``Qualified'' Covered Call Options	203	(4)
Appendix D: Twenty-Stock Covered Call Study	207	(11)
Bibliography	218	(1)
Glossary	219	(6)
Index	225