Was the Covered Write Strategy Successful? Not so much…yet

by JDH on June 16, 2012

Last week I revealed that it appeared I had outsmarted myself on my covered call writing strategy, as a follow up to the previous week’s commentary: Nice Bounce for Gold – Did I Cover Too Soon?  To review, 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, for $1.15  My plan was simple: if the share price remains under $42, the options expire worthless on June 16, and I pocket the $1.15 premium.  If the share price drops, I still own my shares.  If the share price goes up over $42, I lose my shares.

So what happened?

At the close of trading on Friday June 15 Agnico-Eagle closed at $42.91.

Of course, watching the share price I realized it was likely to close above $42 resulting in the loss of my shares, so before the close on Friday I repurchased the options I had previously sold.  For how much?

95 cents.

With commissions, the 10 contracts, representing 1,000 shares:

We sold for $1.15, or $1,338.76 after commissions (meaning I sold something I didn’t have, and took in $1,338.76).  Then, yesterday, I repurchased those options for 95 cents, for a total cost, including commissions, of $1,261.24

So, in total, I made a profit of $77.52 on my options.  In other words, I broke even.

Actually I did better than break even, because the shares I paid an average of $35.67 for are now worth $42.91, for a gain of about 20%.  That’s pretty good.

There are two key points here:

First, the covered writing strategy provided me with some downside protection, at no cost.

Second, even though I guessed correctly that the stock would go up, if I had BOUGHT the options instead of selling them, I still would have lost money!

I found a stock that went up 20% in less than two months, and yet because of the eroding value of options, I would have lost money by buying them.


In my younger days I lost a lot of money playing options.  I’d pick the correct stock, and then I’d say to myself:

Hey, JDH, why invest $35.67 to buy the stock when you can invest $1.15 to buy the option?  With the option you have less capital at risk, and all it takes is a small move in a short period of time to double your money!

True, but all it takes is a small move over a longer period of time to lose everything, which is what inevitably happens when you buy options.

If I was James Dines of the The Dines Letter I would create a Dineism to describe this; I’m not him, but here goes the first ever JDH-ism:

It is better to own something that increases in value, and sell (or rent) an asset that declines in value.

An option has a limited life span; it’s value declines each day, so it is better to sell it, so you can buy it back later when the time value has eroded, as compared to owning it while that value erodes.

Of course it doesn’t always work out exactly as you hope.  Two weeks ago I reported that I bought another blue chip at the same time: RGL.TO – Royal Gold Inc.  I paid $59.82 per share in late April.  On June 4 I covered; I sold the June 76 call options to cover at $3.70, taking in a premium of $3,677.51 after commissions, because at the time the stock had increased to just over $80 per share.

Unfortunately for the covered option strategy the stock kept going up, so instead of losing the shares, on Wednesday June 13 I took my losses and bought back the options, paying $6.50, for a total cost of $6,522.49.


That’s a loss of $2,844.98

Well, not really, because the next day I turned around and sold the JULY 72 call options for $10.85 for a total premium of $10,827.51. after commissions.  The stock was trading at over $82 at the time.

By the end of the day Friday the stock had dropped a bit, so those same options had dropped to around $8,450 in value.

I could therefore simply buy the options back now for $8,450, and my total profit/loss would be:

Loss of $2,844.98, plus premium of $10,827.51, less cost to buy back of $8,450 = loss of $467.47

I see no point in taking a loss, so my plan is to put in a buy order at $6.  If I get filled at some point before the third Friday in July when the options expire, the math will look like this:

Loss of $2,844.98, plus premium of $10,827.51, less cost to buy back of $6,000 = profit of $1,982.53

My point: if you keep rolling over your position long enough, eventually you make a profit.  The game is rigged in your favor, because the option is a depreciating asset; it loses time premium every day.

Of course the options are only one side of the story.

Both of the stocks I mentioned have increased significantly in value, so I’ve made great money on the underlying stocks.

Even better, on June 15 I received a dividend of $262.21 on my 1,000 shares of AEM.TO – Agnico-Eagle Mines Ltd. and Royal Gold also pays dividends, further increasing my return.

This approach may not be sexy, but it is profitable, so barring a massive crash, I see no reason not to stay the course.

Thanks for reading; see you next week.