Home Articles Options Writer Series — Why Write Covered Calls?

Options Writer Series — Why Write Covered Calls?


By Warren Kaplan

The Stock Option Writer

© Warren Kaplan 2011-2018

March 23, 2018

Covered call writing is the very basic option strategy for option writers. Do you know what option writing is like? A covered call is a situation whereby you own the underlying stock that you have sold an option against. There is such a thing as an uncovered call. That is selling a call and obligating yourself to deliver shares that you do not own. I do not recommend that unless you are a professional and experienced stock trader. Note the word TRADER.

It is like selling an insurance policy for a premium. When you buy insurance, the insurance company gets your money immediately before the insurance is in effect. The insurance covers a certain period of time and for a stated amount. Well when you sell a covered call, you are doing the same thing. You are selling the buyer the right to buy the shares of a specific company for a specific period of time and at a specific price. So, if you sold a covered call for example  Carnival Cruise Lines CCL at $71.00, the option  buyer has the option to buy it from you at that price. Let me give you a real example. On March 9, 2018, I sold 2 covered calls on CCL with a $71.00 strike price that expires on March 23, 2018. I did this in one of my family trading accounts. My trading accounts are designed to operate on a short-term basis, but more about that later. The stock was selling at $66.91 at that time, which happens to be the closing price on Friday March 19. I received $10.00 per one contract. A contract consists of 100 shares. Hence, I have given someone the right to buy 100 shares from me at $71.00 per share until the close of the stock market on March 23, 2018. Since I got $10 for a 2-week option, it is like getting $260.00 for a full year. $260.00/$6,691.00 = 3.89%. That is added to my income as the normal dividend for CCL is $1.80 a year. 100 shares pays me $180 per year. Hence, I have increased my income from 100 shares of CCL by 144.44%. I have a cost of $65.76. So, if the stock rises above $71,00 by March 23, 2018 and the option buyer calls. (buys) my shares, I have a nice capital gain of $5.24 per share. That is $524.00 on my 100 shares. Why did I sell that option at that price? Based on my 60-years of experience, I do not think the stock will be called and I took it as an opportunity to take in premium money and if it got called away, I have a capital gain. As I see it, I win either way. OK, but what if the stock goes down? Well long term (within 3-years), I believe the stock will sell in excess of $100.00 a share. This is based on my knowledge of the company and additional research. Yes, I could be wrong, but investing in the stock market is always taking a risk. I have been investing since I was 13 years old, 68 years ago. By now, I think I have a feel for it. If the stock was volatile, I could have used the premium I received to have bought a put option at a lower than market strike price. Such an action is called a collar. I very rarely do that. I am always convinced that I am right otherwise, I wouldn’t buy and sell shares. I believe an investor should always look at a company and decide whether the total capitalization of the company is worth its implied value. The market cap of CCL is $35.6 billon. Compare that to the growth, unprofitability and of course no dividends for Tesla ($321.35), which has a market value of $55.0 billion, well you can make your own judgment call.

The point I really want to make is that one should consider selling covered calls for additional income. In some of my family investment (not trading) accounts, I have sold the following covered CCL calls for added income. On January 24, 2018, after previous covered calls expired worthless, I sold April 20,2018 calls strike price $8.00 for $20 per 100 shares and July 20, 2018 calls strike price $85.00 for $35.00. In my investment accounts, I tend to write longer term calls at higher strike prices when it comes to CCL. I would like to see the stock price increase but not really sell the shares at those levels but I am mentally prepared to do so without regret. I have even sold covered CCL calls with a strike price of $95.00.

Covered call is not for everyone. As I have constantly preached: you need an objective when you are buying shares of any company. Ask yourself, why are you buying it and you must define the reason as a number. In the case of CCL, I have a number and a time period. I never know if I will obtain that price in that period of time. However, that gives me a guide line. More and more, I am looking at the value of the company based on its current market price.  So, my feeling is the higher a stock price (and hence market value) goes, the less I am attracted to it. There are several other factors I look at too. Since the management is taking a generous salary plus expenses, what is the Board allocating, if anything, to shareholders? Warren Buffett is famous for only buying stocks of companies that pay a dividend. He also loves premiums from insurance companies and is the proud owner of GEICO.

Here are my best “tips”. Layout a few bucks and buy 2 of the Michael Sincere books: “Understanding Stocks” and “Under Standing Options” For great stock ideas, the best one I have found is Sure Dividend · 7941 Katy Freeway #163 · Houston, TX 77024 · USA  This is by Ben Reynolds, support@suredividend.com. His ideas are magic. And lastly, if you want some exciting reading, find James J. Cramer’s’ Addiction of a Street Addict, copywritten in 2002.

I currently have a position in the above-mentioned stocks. Option writing is NOT for everyone. Check with your investment advisor.

Warren Kaplan has been writing options for 50 years. He has been a stockbroker, investment banker and brokerage owner.  He currently owns and operates Kaplan Asset Management, a provider of financial assistance for small to middle market businesses. He has more than a half-century of experience in dealing with financial markets, giving guidance and consulting with management, and assisting in the development of business strategies and solutions. The Company has assisted and consulted many successful companies, such as Natures Bounty (NBTY) and Action Products International (APII), helping them to go public and trade on the NASDAQ stock exchange. His philosophy is to “do something with the profits.” “If you make $100 in the stock market, take 50 percent and invest it back into the market. Then, take the other 50 percent and buy yourself something.”

Additional disclosure: I am not a registered investment adviser and I do not give investment advice. Nothing in this article should be construed as investment advice. Investors are encouraged to do their own research and seek the advice of an investment professional before investing. Writing options is not for everyone.  This article was written for informational purposes only.