Well, I sort of won this week. Allow me to explain.
For the last few months I have operated under the assumption that the price of gold, long term, is going much higher. In fact, I am on record as predicting that by year end gold will be $1,600 per ounce, but I expect to drop to $1,000 by the end of March before rising rapidly over the balance of the year. Armed with that perspective, I want to hold my gold shares, because it’s impossible to pick the exact bottom.
So, in order to retain my gold shares but to earn an increased rate of return, I sold calls against some of the blue chip gold stocks I own.
For example, on January 2, 2014 I sold the RGL.TO – Royal Gold Inc. January 52 calls for $1.50 each. At the time of the sale Royal Gold was trading around $51.50, so I thought it was a good deal. As long as Royal didn’t increase over $52 by the time the options expired at the end of trading on January 17, I would keep $1.50. Even if Royal increased all the way to $53.50 I would still break even on the deal.
As luck would have it, by the end of the morning on January 17 Royal Gold was trading at around $60 per share. That’s right, a quality gold stock that had fallen from $80 at the start of 2013 to $46 just before Christmas 2013 was staging a remarkable bounce back, increasing by over 16% in 11 trading days.
Wow.
Of course, had I known that a stock that lost almost half it’s value in 2013 was going to go up by more than 1% a day to start 2014 I would have bought call options, not sold them. I would have made a ton of money.
Alas, the opposite happened, so on Friday morning I took my medicine like a man and bought back the calls I had sold.
I sold them for $1.50.
I bought them back for $8.05.
Ouch. Excluding commissions, I lost $6.55 on the deal.
Perhaps “lost” is the wrong word. I still own the stock, and the stock has increased from $51.50 to $60, so my stock has increased by $8.50, so I’m very happy about that. Also, on January 17, Royal Gold paid me a dividend of 19 cents per share, so I’m ahead by almost $8.70 in the period on my stock holdings. That’s good.
The Lesson Learned
In a rapidly rising market, selling calls is not a good idea. Just hold the stock, or be aggressive and buy calls, but don’t sell them. If I had done nothing I would be ahead by $8.70. By selling calls my $8.70 profit in the stock is reduced by the $6.55 loss on the calls, for a net profit before commissions of $2.15.
A $2.15 profit on a $51.50 stock in 11 trading days works out to a 100% profit on an annualized basis, which is great, but not as high as the “un-hedged” 400% I would have earned by doing nothing.
So have I learned my lesson? Will I stop doing covered call writing?
Nope.
In fact, on Friday afternoon, I did it again. This time I placed an order to sell the Royal Gold February 62 calls for $1.55, and I was filled at that price.
So, if Royal Gold increases by less than 3% between now and the third Friday in February I keep $1.55, and all is good. If it increases by more than that, I’ll look silly, again.
However, Royal, and many of the gold stocks, have increased very quickly, and in a normal market some form of pullback would be expected.
As you can see from the chart, the Relative Strength Index closed Friday at over 76, which is in very over-bought territory. The green boxes show the stock well over it’s 200 Day Moving Average, and that’s usually an indication that a pull back will happen, and in fact it may have already started. I re-covered on Friday afternoon around 2:30 pm with RGL trading just over $60, and by the end of the day it was down to $58.70, so the pull back perhaps as started.
I will therefore wait, and watch, and if the pullback happens, I’ll cover my calls and be thankful that I mitigated my losses.
I don’t always win, but with this strategy, even when I “lose”, I’m still satisfied.
As an aside, I picked the worst example. I also did covered writes this month on AEM.TO – Agnico-Eagle Mines Ltd., G.TO – Goldcorp Inc., FNV.TO – Franco-Nevada Corp., and SLW.TO – Silver Wheaton Corp., and my results were much better on those stocks, since they did not move as high on the week. In fact, on the Goldcorp covered write I actually made money, since I was able to unwind my position at around the $25 call strike price. Sometimes the strategy works quite well.
That’s my report for this week. Thanks for reading, and see you next week.
Gold Covered Call Strategy: Sometimes it Works, Sometimes Not So Much
by JDH on January 18, 2014
Well, I sort of won this week. Allow me to explain.
For the last few months I have operated under the assumption that the price of gold, long term, is going much higher. In fact, I am on record as predicting that by year end gold will be $1,600 per ounce, but I expect to drop to $1,000 by the end of March before rising rapidly over the balance of the year. Armed with that perspective, I want to hold my gold shares, because it’s impossible to pick the exact bottom.
So, in order to retain my gold shares but to earn an increased rate of return, I sold calls against some of the blue chip gold stocks I own.
For example, on January 2, 2014 I sold the RGL.TO – Royal Gold Inc. January 52 calls for $1.50 each. At the time of the sale Royal Gold was trading around $51.50, so I thought it was a good deal. As long as Royal didn’t increase over $52 by the time the options expired at the end of trading on January 17, I would keep $1.50. Even if Royal increased all the way to $53.50 I would still break even on the deal.
As luck would have it, by the end of the morning on January 17 Royal Gold was trading at around $60 per share. That’s right, a quality gold stock that had fallen from $80 at the start of 2013 to $46 just before Christmas 2013 was staging a remarkable bounce back, increasing by over 16% in 11 trading days.
Wow.
Of course, had I known that a stock that lost almost half it’s value in 2013 was going to go up by more than 1% a day to start 2014 I would have bought call options, not sold them. I would have made a ton of money.
Alas, the opposite happened, so on Friday morning I took my medicine like a man and bought back the calls I had sold.
I sold them for $1.50.
I bought them back for $8.05.
Ouch. Excluding commissions, I lost $6.55 on the deal.
Perhaps “lost” is the wrong word. I still own the stock, and the stock has increased from $51.50 to $60, so my stock has increased by $8.50, so I’m very happy about that. Also, on January 17, Royal Gold paid me a dividend of 19 cents per share, so I’m ahead by almost $8.70 in the period on my stock holdings. That’s good.
The Lesson Learned
In a rapidly rising market, selling calls is not a good idea. Just hold the stock, or be aggressive and buy calls, but don’t sell them. If I had done nothing I would be ahead by $8.70. By selling calls my $8.70 profit in the stock is reduced by the $6.55 loss on the calls, for a net profit before commissions of $2.15.
A $2.15 profit on a $51.50 stock in 11 trading days works out to a 100% profit on an annualized basis, which is great, but not as high as the “un-hedged” 400% I would have earned by doing nothing.
So have I learned my lesson? Will I stop doing covered call writing?
Nope.
In fact, on Friday afternoon, I did it again. This time I placed an order to sell the Royal Gold February 62 calls for $1.55, and I was filled at that price.
So, if Royal Gold increases by less than 3% between now and the third Friday in February I keep $1.55, and all is good. If it increases by more than that, I’ll look silly, again.
However, Royal, and many of the gold stocks, have increased very quickly, and in a normal market some form of pullback would be expected.
As you can see from the chart, the Relative Strength Index closed Friday at over 76, which is in very over-bought territory. The green boxes show the stock well over it’s 200 Day Moving Average, and that’s usually an indication that a pull back will happen, and in fact it may have already started. I re-covered on Friday afternoon around 2:30 pm with RGL trading just over $60, and by the end of the day it was down to $58.70, so the pull back perhaps as started.
I will therefore wait, and watch, and if the pullback happens, I’ll cover my calls and be thankful that I mitigated my losses.
I don’t always win, but with this strategy, even when I “lose”, I’m still satisfied.
As an aside, I picked the worst example. I also did covered writes this month on AEM.TO – Agnico-Eagle Mines Ltd., G.TO – Goldcorp Inc., FNV.TO – Franco-Nevada Corp., and SLW.TO – Silver Wheaton Corp., and my results were much better on those stocks, since they did not move as high on the week. In fact, on the Goldcorp covered write I actually made money, since I was able to unwind my position at around the $25 call strike price. Sometimes the strategy works quite well.
That’s my report for this week. Thanks for reading, and see you next week.