39 lines
3.0 KiB
Plaintext
39 lines
3.0 KiB
Plaintext
Chapter 2: Covered Call Writing
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PROJECTED RETURNS
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59
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The return that one strives for is somewhat a matter of personal preference. In gen
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eral, the annualized return if unchanged should be used as the comparative measure
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between various covered writes. In using this return as the measuring criterion, one
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does not make any assumptions about the stock moving up in price in order to attain
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the potential return. A general rule used in deciding what is a minimally acceptable
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return is to consider a covered writing position only when the return if unchanged is
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at least 1 % per month. That is, a 3-month write would have to offer a return of at
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least 3% and a 6-month write would have to have a return if unchanged of at least
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6%. During periods of expanded option premiums, there may be so many writes that
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satisfy this criterion that one would want to raise his sights somewhat, say to 1 ½% or
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2% per month. Also, one must feel personally comfortable that his minimum return
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criterion - whether it be 1 % per month or 2% per month - is large enough to com
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pensate for the risks he is taking. That is, the downside risk of owning stock, should
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it fall far enough to outdistance the premium received, should be adequately com
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pensated for by the potential return. It should be pointed out that 1 % per month is
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not a return to be taken lightly, especially if there is a reasonable assurance that it can
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be attained. However, if less risky investments, such as bonds, were yielding 12%
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annually, the covered writer must set his sights higher.
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Normally, the returns from various covered writing situations are compared by
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annualizing the returns. One should not, however, be deluded into believing that he
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can always attain the projected annual return. A 6-month write that offers a 6%
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return annualizes to 12%. But if one establishes such a position, all that he can
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achieve is 6% in 6 months. One does not really know for sure that 6 months from now
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there will be another position available that will provide 6% over the next 6 months.
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The deeper that the written option is in-the-money, the higher the probability
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that the return if unchanged will actually be attained. In an in-the-money situation,
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recall that the return if unchanged is the same as the return if exercised. Both would
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be attained unless the stock fell below the striking price by expiration. Thus, for an in
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the-money write, the projected return is attained if the stock rises, remains unchanged,
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or even falls slightly by the time the option expires. Higher potential returns are avail
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able for out-of-the-money writes if the stock rises. However, should the stock remain
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the same or decline in price, the out-of-the-money write will generally underperform
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the in-the-money write. This is why the return if unchanged is a good comparison.
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DOWNSIDE PROTECTION
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Downside protection is more difficult to quantify than projected returns are. As men
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tioned earlier, the percentage of downside protection is often used as a measure. This |