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Add You - Why Covered Call Traders Lose Money
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- When the stock is below the breakeven
- When the stock is below the support
- Stock > strike for OTM
- Stock < strike for ITM
Next is how many positions to trade with? This is a very importan
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However, if you want to do better than the market, you better have a plan. Covered Calls is a way to do so.
Covered calls are the most conservative of all the various option strategies. It seems pretty simple but, many people have trouble making money with them. Most of their problems are one of four things: (1) failure to properly screen good CC candidates (2) failure to monitor and manage your positions once in them (3) not being in enough positions to be diverse and (4) not trading with enough money and thus commissions and taxes take most or all of your profits.
(1) Failure to properly screen positions
I use OptionsXpress and they are great, but at the time of this writing, their covered call screener is lacking. The best one I have found is at Option Monitor. It costs only $35 per month and can screen for about twenty different items. The very useful ones that I use that OptionsXpress do not have are percentage in or out of the money, market capitalization, and percentage above or below the 52wk high or low. Paying another service around $60 or more per month so they can use their "special screener" to show you pre-screened choices is a waste of your money.
Some CC writers just starting out (like myself) go to a site like coveredcalls.com and look at the highest yielding CC positions and go to town. This is an absolute recipe for disaster (I lost 40% in three days, luckily I was paper trading). Those stocks are WAY too volatile and are usually tiny medical related companies. A good CC trader should be very picky in which positions he is going to use.
(2) Management
I learned about CC's from a guy who was trading during the roaring bull market in 1999-2000 and got absolutely slammed when the market crashed. One of the fundamental things he did wrong was that he failed to set STOP orders for his positions and ended up loosing about 70-80% after he couldn't produce cash for margin calls. Determining your exit strategy is absolutely vital to any CC trader.
Another item that deals with management is rolling up, down, or out. Some CC traders look at just their account balance to see how they are doing.
If your stock has gone down but is still good fundamentally, is rolling down a good option? What if the option has lost all of its time value and rolling out right now can lock in your profit? The bottom line is that you can not just look at the current prices in your account and determine if you should do anything. You need a calculation tool to tell you when you should make management decisions. I have created and currently use an excel spreadsheet that I think is fantastic. It calculates multiple items such as
- Returns if flat and Returns if called out
- Current Return based on current prices of the stock and option
- Shows a roll-over option for rolling up or down
- Downside protection percentage
- Percentage ITM or percentage OTM
- When the stock is below the breakeven
- When the stock is below the support
- Stock > strike for OTM
- Stock < strike for ITM
Next is how many positions to trade with? This is a very important
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(1) Failure to properly screen positions
I use OptionsXpress and they are great, but at the time of this writing, their covered call screener is lacking. The best one I have found is at Option Monitor. It costs only $35 per month and can screen for about twenty different items. The very useful ones that I use that OptionsXpress do not have are percentage in or out of the money, market capitalization, and percentage above or below the 52wk high or low. Paying another service around $60 or more per month so they can use their "special screener" to show you pre-screened choices is a waste of your money.
Some CC writers just starting out (like myself) go to a site like coveredcalls.com and look at the highest yielding CC positions and go to town. This is an absolute recipe for disaster (I lost 40% in three days, luckily I was paper trading). Those stocks are WAY too volatile and are usually tiny medical related companies. A good CC trader should be very picky in which positions he is going to use.
(2) Management
I learned about CC's from a guy who was trading during the roaring bull market in 1999-2000 and got absolutely slammed when the market crashed. One of the fundamental things he did wrong was that he failed to set STOP orders for his positions and ended up loosing about 70-80% after he couldn't produce cash for margin calls. Determining your exit strategy is absolutely vital to any CC trader.
Another item that deals with management is rolling up, down, or out. Some CC traders look at just their account balance to see how they are doing.
If your stock has gone down but is still good fundamentally, is rolling down a good option? What if the option has lost all of its time value and rolling out right now can lock in your profit? The bottom line is that you can not just look at the current prices in your account and determine if you should do anything. You need a calculation tool to tell you when you should make management decisions. I have created and currently use an excel spreadsheet that I think is fantastic. It calculates multiple items such as
- Returns if flat and Returns if called out
- Current Return based on current prices of the stock and option
- Shows a roll-over option for rolling up or down
- Downside protection percentage
- Percentage ITM or percentage OTM
- When the stock is below the breakeven
- When the stock is below the support
- Stock > strike for OTM
- Stock < strike for ITM
Next is how many positions to trade with? This is a very importan
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(2) Management
I learned about CC's from a guy who was trading during the roaring bull market in 1999-2000 and got absolutely slammed when the market crashed. One of the fundamental things he did wrong was that he failed to set STOP orders for his positions and ended up loosing about 70-80% after he couldn't produce cash for margin calls. Determining your exit strategy is absolutely vital to any CC trader.
Another item that deals with management is rolling up, down, or out. Some CC traders look at just their account balance to see how they are doing.
If your stock has gone down but is still good fundamentally, is rolling down a good option? What if the option has lost all of its time value and rolling out right now can lock in your profit? The bottom line is that you can not just look at the current prices in your account and determine if you should do anything. You need a calculation tool to tell you when you should make management decisions. I have created and currently use an excel spreadsheet that I think is fantastic. It calculates multiple items such as
- Returns if flat and Returns if called out
- Current Return based on current prices of the stock and option
- Shows a roll-over option for rolling up or down
- Downside protection percentage
- Percentage ITM or percentage OTM
- When the stock is below the breakeven
- When the stock is below the support
- Stock > strike for OTM
- Stock < strike for ITM
Next is how many positions to trade with? This is a very importan
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If your stock has gone down but is still good fundamentally, is rolling down a good option? What if the option has lost all of its time value and rolling out right now can lock in your profit? The bottom line is that you can not just look at the current prices in your account and determine if you should do anything. You need a calculation tool to tell you when you should make management decisions. I have created and currently use an excel spreadsheet that I think is fantastic. It calculates multiple items such as
- Returns if flat and Returns if called out
- Current Return based on current prices of the stock and option
- Shows a roll-over option for rolling up or down
- Downside protection percentage
- Percentage ITM or percentage OTM
- When the stock is below the breakeven
- When the stock is below the support
- Stock > strike for OTM
- Stock < strike for ITM
Next is how many positions to trade with? This is a very importan
The times of the stereotypical used car salesperson approach to selling are rapidly becoming pass?. Most people do not seem to be impressed anymore with someone kicking the tires, telling them the car they are considering is a deal of lifetime, and then being high pressure sold into purchasing.I believe the reason for this has to do with technological advances, and the amount of brands, sizes, and features people have to choose from today. In earlier times you did not need a master’s degree in electronics to hook up your television, or simply turn it on. Most people picked the television that had what they considered to be the best picture quality, or the one a sales person recommended as his/her biggest mover. The majority of these units turned on and off fundamentally the same way. Installation was as easy as plugging them in. The manufactures would for the most part set the dealer cost and suggested retail price. The owners of the stores would get volume discounts therefore allowing them more profit. Ma
- When the stock is below the breakeven
- When the stock is below the support
- Stock > strike for OTM
- Stock < strike for ITM
Next is how many positions to trade with? This is a very important question. A great book by Burton G Malkiel, A Random Walk Down Wall Street, has an explanation about the differences between systematic and unsystematic risk. To summarize, systematic risk is the fundamental risk of the market as a whole. Since the market has risk and all stocks follow the market to an extent, systematic risk CAN NOT BE DIVERSIFIED AWAY. Systematic risk is the risk of the market.
Unsystematic risk is the risk of individual companies such as them getting sued, the CEO getting caught lying to shareholders, or inventing a miracle drug. It is this unsystematic risk that can be diversified away. So how many positions should you get into?
The above book has a graph that unsystematic risk goes down exponentially to zero after twenty stocks (how he got twenty I am not sure, but it makes sense). So should you get into twenty positions? No, because CC's offer downside protection. My personal feeling is at least five, but preferably seven to ten. More than ten is fine, but I think you are all ready diversified enough and are just wasting your time and trading expenses.
If a CC trader does not take diversification into account, he/she is asking for trouble. Just like an "investor" needs to be diversified, so does a covered calls "trader". Therefore, you need to develop some sort of method to track which industries you are currently in. A great way to do that is to use my covered call calculator. In it there is a section to enter the industry so you do not forget which industries you are all ready invested in.
(4) Money Management
Covered calls have their disadvantages, to think otherwise is naive. One of them is that you have double the amount of trades than just owning stock and thus commissions are around twice as much (but usually more since option commissions are generally higher)
Also, if done outside an IRA, there will be short term capital gain tax rates
"Capital gains on assets held for a year or less are taxed at your ordinary income tax rate (anywhere from 28% to 39.6%, depending on your specific ordinary tax rate). Capital gains on assets held for more than a year are taxed at a reduced tax rate of 20%"
At the time of this writing, OptionsXpress charges $12.95 for an option buy or sell (but $0 for being called out) and $9.95 for a stock (these are both the active trader discount, both go up to $14.95 without the active, however if you do not qualify for this, you are not following rule 3). So the minimum transaction cost per position is (2x$9.95 + $12.95) $32.85.
The following is an explanation of how much you should invest in per position taking into account taxes and trading costs. Let us assume a standard profit of 3% per position (this is very reasonable). The following is how much money 3% is for different amounts of position values.
- $2000 - $60
- $3000 - $90
- $4000 - $120
- $5000 - $135
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