Category: Beginners

A couple of days ago I placed a limit order to sell naked (uncovered) calls on Shutterfly (SFLY).  I’ve profited on SFLY calls twice in the past few months doing the same thing and figured little has changed for it’s near term future and dove back in for more. While SFLY was trading at $15.67, I sold four June 17.50 naked calls (QFYFW) and received $307 after commissions. 

Covered calls are a lot more popular because the risk is perceived to be lower, but that’s not 100% true.  The upside risk is much lower, but the downside risk is much better by not taking ownership.  I think that SFLY could fall lower than its current price, so I am not taking ownership of the underlying stock and therefore am not taking on the downside risk.  I am accepting risk to the upside in that SFLY could climb to 25, 50, 100 or any higher price, but I just don’t think that’ll happen.  If SFLY climbs above 17.50 by options expiration, I’ll be forced to sell 400 shares which I don’t own, essecially I’m shorting the stock now, but with a cushion and a limited profit.

I’m starting to do this type of trade more often.  The day after earnings are released, when earnings news specific to the underlying equity shouldn’t offer a surprise before my option expires, I like to sell naked puts. That’s what I did with Intel (INTC) today.

Obviously, the premium would have been much better if I had sold the options prior to earnings announcement, but I would have taken on more risk than needed. I’m not saying this is a hard rule for me, but something I’ve done more than a few times and it has worked.  You’d think the premiums would drop so fast that you couldn’t take advantage of the change in factors (ie, earning are no longer an unknown and volatility should drop), but I’ve seen it fairly often that in the first hour or two investors are still digesting the news and while premiums drop, it’s not as much as maybe they “should”.

Ideally one should sell naked puts early in the day if you are trying to work this angle.  Some extra risk is added in that some stocks work off their short positions with a spike early and fall back soon after.  That’s what you have to watch.  You can generally tell in the first 15-20 minutes if the gapped up open will be a head fake and the stock is just working …

Back on February 22nd I entered a limit on Cummins, Inc (CMI) when it was above 53.00.  That order hit just after market open this morning while CMI was trading around $47.75.  I sold two April 45 naked puts (CDMPI) and received $388.50 after commissions. 

Since it has been a few weeks, I’m not sure, but think I found this one in Barron’s.  I charted it back then and saw that 53 was too high for me.  Charting it again today I see that I must have expected the low from the beginning of February to act as support around 45. CMI is pretty close to that now, so this will be a good test.  It hit this 45 range five times in mid-Jan to early Feb and used it as a floor or ceiling each time.  Again, I’m banking on the chart. 40 could be the next speed bump if this current level breaks.  This is another stock from the Diversified Goods sector to add to my CAT position which I expect to exit in two weeks.

Speaking of exiting positions in two weeks, I just ran a sanity check on my current holdings.  I thought I might have been losing on some puts since the market has been dropping so quickly, but see that I’m only sitting on paper losses on two, VIP and DIS, but VIP …

I’ve talked a lot lately about my bad trades, but I am taking a moment to reflect on the good which is most of what I’ve had the past few weeks.  It’s just that one bad trade can beat out a few good trades.  It continues to be a numbers game with my trading model.  I have to make sure I maintain my search for good trades to have premiums that help balance out my losses on positions like NVDA. 

I had the following options expire as of close yesterday.  The yellowish squares on the right show which options expired in-the-money (ITM).  Two were covered calls circled in green showing that I’ll be receiving cash from the sale of my shares being called away.  The two circled in red show that I had too high of a strike and will have to pay when the shares are assigned Monday morning.  The blue circles show what I would have had to pay above and beyond what I received if I wanted to get out of these positions before expiration.

 

I get to keep all the premiums since I didn’t buy back any of the options above.  All those gains go to cover stocks like MRO and my loss of $2500 that I will realize once the shares are called away.  I’ve written options on MRO for months and now …

Had the month lasted one day longer I wouldn’t have had to post that the Dow Jones ($DJI) was beating me for the past 12 months.  I had a $2200+ rally on Friday that made all the difference and put me ahead of the Dow again.  That’s how simple this thing can be.  What a difference a day makes.  The Dow was up to, but once again I’m ahead.  My new 12 month trailing return is +5.76%.  We have a rocky road ahead, so I’m not getting cocky about that.  We could easily have another fall that rocks me even harder.

While I loved my streak of being ahead of all major indexes, these hick-ups are good to have sometimes to remind me I’m not infallible. If my streak had lasted much longer I would have likely turned my confidence to being cocky.  I will make mistakes and as tempting as it can be to over-invest, the safer long term strategy for me needs to remain not over committed with short option positions.

Once you get cocky as an investor, the losses are close behind.  I set my maximum investment to go as high as twice the underlying value of my options.  Even in a bear market, not all options will be assigned at the same time if I’ve timed it wrong.  If all somehow are, I should …

If you are going to enter into the world of selling options you have to know your options (pun intended) and the risks that come with each. I love to sell options because I like receiving premiums rather than paying premiums, much like an insurance company.  Option selling strategies can vary greatly.

I’ve done very well with selling time value, mainly with naked put options and sometimes selling call options too.  One of the tricks is to know when to sell which stock options - calls or puts.  The reason some investors don’t like to sell premiums using put options is the increased risk associated with leverage during a bear market or even just a small, quick correction. The same risk can be present with call options, but to the upside in a bull market.  The easiest way to protect against that concern is to not sell options on more than you can afford to buy.  I typically try to follow that mantra, but have veered off course some during this month’s collapse. 

The best way I can illustrate how to balance the overshoot is to walk through the trades I have going on Alcoa (AA) right now.  All of the options I’m describing below expire in February.

I started off with a normal trade for me and sold four naked puts at the 30 strike on 1/10/08 while AA was …

I was down by almost $3200 again today by the end of my lunch break.  That’s when everything changed.  I ended the day up almost $350. 

I sold 2 MRO Feb 50 calls (MROBJ) and received $149.50 after commissions.  This trade was to cover my Feb 50 puts and give me more cushion to the downside.

I sold 2 MRO Feb 45 covered calls (MROBI) and received $368.50 after commissions. This trade was to cover the 200 shares I own already.  MRO was down another $3+ when I sold these new two sets of calls and it ended the day up more than $0.50.  Clearly I wasn’t expecting such a rally as I left a bunch of money on the table.

I sold 1 BA Feb 80 call (BABP) and received $109.25 after commissions.  This was to cover my 100 shares of BA I already own.  I have two other Feb 85 calls by themselves still too.  I am banking on BA not rallying $8.50+ in the next 17 trading days.

I sold 2 ADBE Feb 35 calls (AEQBG) and received $108.50 after commissions.  ADBE was down another $1 or so when I made this trade.  It closed up $0.33.  This trade was to cover two Feb 40 naked puts I have a fat paper loss on.  I’m basically securing a loss for myself if ADBE closes at expiration …

Kopin Tan had a great line in this week’s Barron’s.
“Like beer bellies and bald spots, a recession is one of those things whose precise beginning is hard to pinpoint - until the sad evidence eventually becomes hard to refute.” 
We have no true way other than guess if we are actually in a recession yet, but we do know the indices are down and most of our accounts show its harsh reality.  The same Barron’s article pointed out that based on data from the 1973, 1980, 1981 and 1990 recessions, “on average, the S&P 500 fell 23% from it’s peak.” That means we might only be half-way to the bottom of where we’re heading if we are indeed heading towards a recession.  With that fear in the minds of many, I’m going to go with the belief that even if we don’t keep dropping another 10-13% we are not likely for a massive rally that lasts months in the near future and I’m going to start selling more naked calls to try to prosper from it. 

I received the above table in an automated email from TD Ameritrade I get weekly.  I like the quick view of the indices’s returns or in this case, lack there of.  Checking out the “big picture” like this always makes me feel better when I’ve had a bad few weeks.  I …