Covered Call Writing: It Worked This Month

by JDH on July 18, 2009

I have continued to advance the position that the current rally won’t last, and reality will catch up to this market and drive it decisively downward later this summer. To that end, I took all of my gold and silver stocks and, two weeks ago, I covered them. For example, with AEM.TO – Agnico-Eagle Mines Ltd. trading under $62 two weeks ago, I sold the July 62 calls for $1.32. The stock closed yesterday at $61.96, so those options expired worthless. I got to keep the $1.32 premium, and I still own the stock. Perfect.

However, lest you think I am some brilliant stock market technician, all of my other covered writes worked out less well. Here’s the summary:

Stock Calls Sold 07/17 Close Option Premium Loss on Stock Sale Net Profit
July 62 $61.96
$1.32
$0.00
$3.66
July 40 $41.04
$1.25
$0.32
$0.21
July 22 $22.32
$0.51
$1.04
$0.19
July 21 $21.74
$0.65
$0.74
-$0.09
July 9 $9.47
$0.45
$0.47
-$0.02
July 21 $21.37
$1.00
$0.37
$0.63

Note: When I sold the calls on AEM.TO – Agnico-Eagle Mines Ltd. on July 8 the stock the peak price was $59.64, so I could have sold it for that price, or covered it, which I did. Since it’s now at $61.98, I’ve made a profit of $2.34 on the stock, plus a profit of $1.32 on the options, for a total profit of $3.66.

Of course the above analysis ignores commissions. Using K.TO – Kinross Gold Corp. as an example, the sale of 5 contracts (representing 500 shares) cost a commission of $16.24, and the subsequent sale of the shares when called cost another $43. I use TD Waterhouse; different brokers may have cheaper rates. Overall:

  • Sell July 22 calls for $0.51 for gross proceeds of $255, less the commission of $16.24, for net proceeds of $238.76
  • Sell Stock at $22 for gross proceeds of $11,000, less commission of $43 for net proceeds of $10,957.
  • Total Proceeds: $ 11,195.76

My alternative would have been to sell the stock on July 8 for $21, which is about where it was trading when I covered. In that case my proceeds would have been $10,500 less $43 commission or $10,457. I actually generated $11,195.76, so this strategy made me an extra $738.76.

Of course the other alternative would have been to do nothing; simply hold the stocks. Had I done that, I would now own 500 shares of K.TO – Kinross Gold Corp. worth $22.32, which I could sell for net proceeds after commission of $11,117. But, as you can see, that’s less than I generated by pocketing the commission, so my strategy was actually the best strategy, even though I guess wrong about the direction.

For those of you who are still following this discussion (and I assume I’ve lost most of you by this point, but so be it, it’s my blog, you’re not paying anything for it, so stick with me) let me repeat my thought process: I though the markets would fall in the summer. I didn’t want to sell my core gold holdings, because I could be wrong, but I wanted a way to protect against a drop. I could have simply sold the stocks, but then if I was wrong and the market increased, I would lost some profits. I took the middle ground and covered my stocks.

As it turns out, I was wrong. My gold and silver shares are higher now than they were two weeks ago, thanks primarily to a good final week. But, even though I was wrong, I still made more money than I would have made if I was right!

Let me repeat: even though I was wrong, I still made more money than I would have made if I was right!

That, my friends, is the beauty of covered writing in a stagnant market. I milk my stocks for premiums, and I keep the premiums, and in some cases keep my stocks as well.

Of course this strategy makes no sense in a bull market. If Kinross was now trading for $70 I’d look like an idiot, since I would have given up all of that profit. (In practice, if we had a huge up move I probably would have bought back the July options before they expired, and then re-sold the August calls at a higher level, so I would have captured some, but not all, of the profit).

So what do I do from here? I still think we have weakness ahead, so I’m not worried that most of my shares have been sold. However, I like to be in the game, so I plan to put in some stink bids this week, for amounts slightly below where we are trading now, for 20% of the shares I ultimately want to own. Here’s my thinking:

Stock 07/17 Close Stink Bid
$61.96
$55 (since I already own some)
$41.04
$40
$22.32
$21
$21.74
$21
$9.47
$9
$21.37
$20

If the market eases I’ll buy back the shares I sold, at less than I sold them for, and then on any subsequent one or two day jump I’ll cover them again. I suspect that August will be the last month I play this game, since by September the rest of the world should realize the dire straits we are in, and I will prefer to be completely long on these stocks.

Crazy? Perhaps, but it worked in July, so we’ll see how it goes in August. Thanks for reading this overly technical posting; feel free to post your thoughts on the Buy High Sell Higher Forum or in the comments section below; see you next week.