Wednesday, July 09, 2014

Covered Call Writing

When reading articles on the topic of covered calls, talking to others and analyzing various options, be sure to really understand the pros and cons of your decision.  Below we discuss several of the most important topics.

Shorter Term or Longer Term?

Like most topics, there is often lively debate as to which is better: longer or shorter calls. We generally prefer writing options that have a shorter time to expiration; usually a year or less.  We do this for several reasons.

When you write covered calls further out in expiration, you lose control over your money.  It gives you much less flexibility if something in the marketplace or the company changes.  What if volatility changes, the stock market crashes, the company does great or terrible?  If any of these scenarios occur, you are “locked” in to that expiration date.

Additionally, the benefit of receiving more income by going further in expiration decreases exponentially. When you sell an option, you want the price of that option to decline.  Because time decay happens more quickly closer to expiration, we prefer to sell shorter term calls to take advantage of this.

Here is a chart and link that explains the issues with using longer-term options.

Take a look at this article, which goes on to further explain that for each option a “sweet-spot” exists with the optimal time to expiration/option price. We agree!

What is the Best Strike Price to Go After?

Answering this question is more of an art than the previous question.  A very generic answer depends on how much income you want from the covered call and at what price are you comfortable “selling” the stock if the stock did go above your strike price.  The more complex answer may start to sound Greek to many investors.  That is because options have various metrics which they are measured by: Delta, Vega, Gamma, Theta, and Rho.  All of these are important for different types of options. Some of our clients receive ongoing solicitations from other advisors who do not understand these concepts. We do! This knowledge and experience is why it is great to have WFG as your advisor! We analyze all that for you before we make a suggestion.


The last issue is timing.  Think back to the day you met your significant other.  How amazing was that timing? We all know, timing is everything. Though it is nearly impossible to predict accurately, the best time to write options is when volatility is higher relative to its average.  Option prices are directly related to the volatility.

For example, this Bloomberg graph shows the historical volatility for CHRW (C.H.Robinson) over the previous year (this graph is for illustrative purposes only).

The yellow line is the volatility over 30 days and the white line is over 10 days.  This type of graph helps to determine the best time to write covered calls, regardless of expiration or strike price.


Although writing covered calls are an easy exercise to execute, it still requires a lot of attention to detail. Make sure you are analyzing these variables when you write calls.

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