Outsmarting Myself on Covered Call Option Writing

by JDH on June 9, 2012

Last week I asked the question: Nice Bounce for Gold – Did I Cover Too Soon? Apparently, in hindsight, the answer is yes, I covered too soon, sort of.  Here’s the story:

On April 20 I bought 500 shares of AEM.TO – Agnico-Eagle Mines Ltd. for $33. On May 9 I bought 500 more for $38.34.  I then sold 10 contracts (to cover the 1,000 shares I own) of the June 42 calls, which expire on June 16, 2012. I sold them for $1.15 each, so in effect I have lowered my cost per share by $1.15.

At the close on Friday June 1, Agnico-Eagle closed at $42.26, so my options were in the money, meaning that if they were to expire that day, I would sell my $42.26 shares for $42.  Fortunately they don’t expire until June 16.

As of the close on Friday June 8, Agnico-Eagle was trading at just under $42, at $41.30.

For a covered call writer, that is almost the perfect scenario.  I buy shares for an average cost of $35.67, I sell calls with a strike price of $42, and the shares go up to just under $42. Perfect.  My shares increase in value, and I get to keep the $1.15 I made by selling the calls.

Of course it’s too early to gloat, because we still have one week to expiration.  If the share price stays where it is, I can gloat.

If the share price goes up, I made the wrong decision; I should have simply purchased the shares and not covered them.

If the share price goes down, I made the wrong decision; I should not have bought the shares, or waited to purchase them at a lower level.

Check back next week and see how it worked out.

Last week I reported that I bought another blue chip at the same time: RGL.TO – Royal Gold Inc.  I paid $59.82 per share, and it closed Friday June 1 at $77.71, for a 30% gain in less than a month.


Even sweeter, as I reported last week, I didn’t cover this one.  I tried, but when I looked at the options available there was nothing out of the money with a decent premium, so I did nothing.  Of course now, I’m glad I did.

So, on Monday June 4, I covered.  I sold contracts for the Royal Gold June call options, strike price $76.  I received $3.68 per share, after commissions.

I thought I was brilliant: I bought the stock for $59.82, and if it trades under $76 I get to keep a further $3.68.  Unfortunately, on June 8 Royal Gold closed at $81.20.  Ooops.

My break even point on the options is a stock price of $76 + $3.68 or $79.68, so at $81.20 I’ve outsmarted myself by a buck and a half.

So what’s the plan?

I’ve got a few choices:

Choice #1: Do nothing.  It’s still five trading days to expiry, so I could simply wait.  If the stock drops between now and expiry, the options may expire worthless, so I keep the premium and my shares.  All is good.

Choice #2: I could take a loss and repurchase the options.  I lose on the options, but the share price is higher, and I keep my shares, so I’m still satisfied.  I lost some of the upside, but not that much.

Choice #3: Take a loss on the options by repurchasing them.  I could then get my money back by selling more options.  For example, based on the closing prices on Friday, I could:

  • purchase the June 76 options for $5.70; I sold them for $3.68, so I lose $1.32
  • I could then sell the July 86 call options for $2

By doing those two transactions I have “traded” my June 76 obligation for a July 86 obligation, and I pocketed another 68 cents in the process. As you can see, I can play this game forever.

If the stock price drops or stays the same, I let the options expire.  If the price goes up, I repurchase the options I sold, and then sell options for next month, at a higher price, to recover my money, and to “raise the bar”.

No stock goes up forever, so at some point the options expire, and I have lots of premiums in my pocket.

What will I do?  That depends on what happens early in the week.  I bought the stocks to hold them, so I don’t want to lose them.  If it looks like my options will be exercised, I will probably repurchase them, and re-cover.

I’ll provide a further update next week.  Thanks for reading.

{ 1 comment… read it below or add one }

rapid1 June 16, 2012 at 1:23 pm

You provide hope that I,too, can do well rapid1