Too Aggressive on the Covered Call Writing Strategy?

by JDH on September 22, 2012

Last week, in my post describing the price action in gold as like trying to push a balloon under water, I explained my covered call writing strategy.  Simply put, I sell calls on stocks I own.  A call option gives the holder of the call the right to purchase my stock at a given price on a given date.  If the underlying stock doesn’t increase in price, I keep the premium.  In a flat or gradually increasing market, it’s a good strategy.  Of course in a rapidly rising or falling market, not so much.

Last week I reported that the strategy worked perfectly.  I sold calls, the market briefly dropped, so I bought back those calls for less than I sold them for to close out my position, and then the market bounced back, so I got the best of both worlds: I retained ownership in stocks that were going up, and I earned an extra premium on the sale of the call options.

So, on Monday September 17, with one week to go until options expiration on Friday September 21, I rolled the dice again.

I sold 10 contracts, representing 100 shares each, of RGL.TO – Royal Gold Inc.   I sold the September 92 calls for 70 cents each, for net proceeds, after commissions, of $677.51

Mid day on Monday Royal Gold was trading for $91.25, so it looked like a good deal for me.  I was getting paid 70 cents for the right to sell my shares at $92, so since they were only trading for $91.25, that was a premium of 95 cents.  Cool.

Well, not so cool, because by 3:00 pm on Friday, one hour before expiration, Royal Gold was trading at $94.38.  Oops.  That meant that they guy who paid 70 cents for my options could now buy my shares from me for $92, and turn around and sell them for $94.38.  He makes a profit of $1.68 on his 70 cent investment.  Not bad for one week’s work.

I didn’t want to lose my shares and need to repurchase them on Monday, so I paid the $2.90 cents required to buy back the options I sold.  Bummer.  That’s a loss for me of $2.20.

Am I crying about it?  No, because the shares were trading for $91.25 on Monday, and they finally closed on Friday at $95.19, so my shares are up by $3.94 on the week.  I don’t get to keep the entire $3.94, because I lost $2.20 on the options strategy, but that’s still a profit for me of $1.74, so that’s better than a loss.

In hindsight, had I known that Royal would go up $3 on Friday, I would have repurchased the calls on Thursday, and I would have had a much bigger profit, but who knew.

My other adventures were losses, but less so:

I sold the September 38 calls on SLW.TO – Silver Wheaton Corp. for 58 cents, and had to pay $1.25 to buy them back on Friday.  However, the stock was up about $1.40 during that period, so while I lost on the options, my stock is up by more than what I lost.

Third example: I sold the September 50 calls on AEM.TO – Agnico Eagle Mines Ltd. for 70 cents, and was forced to repurchase them for 82 cents.  I lost 12 cents on the calls, but the stock was up over $1 on the week, so again I’m not to concerned.  One other point: this week Agnico Eagle paid a dividend of 19 cents per share, which I got to keep, since I owned the stock.

That’s a key point: if you sell the stock, you don’t get the dividend.  If I sell an option against the stock, I still get the dividend, which helps increase my profit.

The same thing happened this week on G.TO – Goldcorp Inc. that paid a dividend on Friday of 4.3 cents.  Every cent helps.

So what have we learned from these adventures?

First, if you think a stock is going to go up, don’t limit your profit by selling call options covered by your stock.  Either let the stock ride, or if you are really aggressive, buy the options yourself.

Over the years I have lost a lot of money buying options, so I don’t do that anymore.  Options are a wasting asset; they expire, which is why I sell them, not buy them.  I don’t want to own a wasting asset, but I’m happy to have sold something that is wasting away.

Second, as soon as you can make a decent profit, take it.

Earlier this month the market moved my way a few days after selling the options (ie. the stocks dropped) so I bought them back and pocketed the difference.  I should have done the same on Thursday, but I didn’t, so Friday it cost me.  Sometimes greed isn’t good.

Third, even when I’m wrong, I still win.  This week I was wrong.  They market went up.  However, as punishment for being wrong, I didn’t lose money, I just made less money.  That’s my kind of bet.  If I’m correct, I make a good return.  If I’m wrong, I make a slightly less good return.  Perfect.

That’s my report this week.  I don’t plan to sell any options this week, four weeks out from the October options expiration, unless we have a big run up in share prices.  I’ll probably wait a week to see where things shake out.

That’s my report; thanks for reading, and see you next week.