covered calls questions

java

Junior member
23 0
I've been trading ES with a spreadbet account for about 16 months and am going to start with an IB account shortly. This also opens up opportunities for extending my investments and i have been looking closely at covered calls. However, this whole options field is totally new to me and there are still some things I'm unclear about.

Is writing covered calls mainly an American thing whereby you buy the underlying stock and then write a call option against it? Is it possible to do this with UK stocks or is a call warrant our UK equivalent?

Everyone I've talked to so far about this is American so I was thinking of trying it out with some US shares on a minimum account size - there's loads of info available for US shares on this. If I understand it correctly, your risk is limited to your holding anyway, but you could lose potential profit if the shares rocket. A number of people seem to be successfully making 3-10% per month regularly doing this, it sounds too good to be true.

Also, would there be any other disadvantages (possibly tax etc) that would be incurred by this sort of trading from the UK?

Thanks
 

RogerM

Established member
752 6
Java - covered call writing is not just for the US, you can do it against UK shares as well. But there are over 2000 optionable shares in the US and just 76(ish) in the UK. As discussed on the daytrading US shares threads, the spreads are very much smaller in the US and commissions lower and no stampduty.

A clear advantage of this type of strategy is that you make money in a sideways market, and have a small cushion against falls. You could use the call premium taken in to buy a put below the price of your share if you want to protect it against a heavy loss - e.g. anothe 911, or a profit warning perhaps.

Risk is very similar to holding the shares - i.e. the risk is that the share price will fall, but at least you get to keep the option premium taken in to offset against losses on the shares. The price for this is that you do not participate in any rise in the share price above the the strike price of the option you have written because the option will lose money £ for £ as the share price rises above it.

If the share price rises strongly and reaches what you consider to be a local top, how do you exit? You can sell the shares for a profit, but then you have a naked call position which will take you to the cleaners if the price rockets further (e.g. a takeover bid perhaps). If you are left holding the calls, maybe consider buying a equal number of calls a couple of strikes higher to limit your potential loss, turning the position into a "credit spread" (or a backspread).

Trading options in the UK is taxed purely on a CGT basis, just like shares.

HTH
 
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T

triplepack

0 0
Covered Calls

Java
Try looking at the cfd of the share as the underlying instrument, with all the benefits i.e. no stamp duty,gearing etc, no comission in some instances.
Also check out IG index as they do an option which is esentially a spread bet, so no cgt ,stamp duty etc. they are cash settled and not exercisable throughout the period of their cycle.
If you haggle with them you can sometimes get the spread down a touch.
Also if you use one provider for both your margin requirments are offset. As you are hedged to a degree.
Triplepack
 

java

Junior member
23 0
Thanks for those replies, but RogerM - can I ask you one more question about what happens if the share price rises strongly?

If this is the case, can't you just sit it out, wait for your shares to be called and accept that although you haven't made as much profit as when owning the shares outright, at least you haven't lost. Surely you will still have a small profit from the actual sale of shares together with the original option premium? (I'm just trying to keep it simple for now, lol). Mmm, I suppose they could subsequently fall back maybe.

Is it also not the case that most options expire worthless, so at least you always get the premium and still own the shares? Obviously this won't happen forever, but it seems that you could generate a steady income stream by having less actual risk exposure than just simply owning the shares in the first place? And if they did go down, couldn't you buy back the calls more cheaply and sell some more to further offset the loss?

Thanks again for the help, and sorry if I'm asking the obvious, but I really am an options newbie, it's very helpful to sort these ideas out.
 

RogerM

Established member
752 6
"RogerM - can I ask you one more question about what happens if the share price rises strongly?

If this is the case, can't you just sit it out, wait for your shares to be called and accept that although you haven't made as much profit as when owning the shares outright, at least you haven't lost. Surely you will still have a small profit from the actual sale of shares together with the original option premium? (I'm just trying to keep it simple for now, lol). Mmm, I suppose they could subsequently fall back maybe."

Yep - sure. Your profit at expiry is capped at the strike price of the short call, and the shares will be called away at the strike price. You may not want to lose the shares at this price, even tho' in profit. You could therefore :-

1. Buy back the calls at a loss - offset by the profits from the shares and keep the shares.

2. Sell more calls higher up in a later month to recoup the loss on the calls in the near month that you have bought back (i.e. rolling up and out)

3. Sell puts below the price, ensuring that you also buy puts further down to protect yourself against a dramatic fall in price, as in a profit warning. This is a backspread, which is put on for a credit with a defined maximum profit and maximum loss.


"Is it also not the case that most options expire worthless, so at least you always get the premium and still own the shares? Obviously this won't happen forever, but it seems that you could generate a steady income stream by having less actual risk exposure than just simply owning the shares in the first place? And if they did go down, couldn't you buy back the calls more cheaply and sell some more to further offset the loss?"

Precisely - but the devil, as always, is in the detail. The problem most covered call writers will face is that if the price of the share rises and you want to sell it for a profit, you are left with a call which may cost you more to buy back than you sold it for in the first place, and even tho' price may be below the strike price you are vulnerable to a spike up in the price of the underlying share if you hang onto the short call without the shares to cover it.

For all that, selling calls is part of my regular income producing strategy.
 
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BBB

Experienced member
1,071 3
Roger M is about right.

If you want to get into options, then I suggest an excellent book called Option Pricing and Volatility by Sheldon Natenburg (something like that - I've just got back from the boozer sorry!). This was the option traders bible when I was on the floor.

Writing options is not as risky as most would believe. 80% expire worthless! I wouldn't do it naked though!

I remember one local who was in a bad way loudly declaring to everyone that 'covering was for p*$$ie$' Two weeks later he left the floor licking a £250,000 loss - ouch! He used to be an excellent trader but he got into a drawdown, ditched his strategy and started playing desperate. He had 15 years of experience previously.

Anyway, enjoy the book. It's worth every penny.
 

java

Junior member
23 0
Thanks very much to you both for taking the time to reply. The reason i was asking was that I spend a lot of evenings in a Hotcomm room, but 95% of the guys are american and a lot of them do these covered calls on the side. There have been a lot of discussion about them, but obviously biased towards the US.

Here's an interesting link to an audio chat (it's quite a large wav. file but the talk is over one hour long). It's what got me thinking abouth this as way of generating a regular monthly profit with less time needed than full on 5 min scalping,lol.

Covered Calls Audio

Hope the link works, and thanks again.
 

RogerM

Established member
752 6
In terms of pure option trading, short puts are exactly the same as a covered call. Of course you must ensure that you have the funds available to buy the stock if it is put upon you, and most brokers will insist that there are sufficient funds deposited to complete a stock purchase in full.

You will of course miss out on the dividends, plus the opportunity to trade the shares and the calls independently, but you also save a commission.

Covered calls are most frequently used as a method of increasing the returns from a portfolio of shares already held rather than as an independent strategy.
 
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BBB

Experienced member
1,071 3
If options are your main vehicle, then you cover with the underlying in order to create a hedge. This is a similar concept to the futures spread.

Even with more complex options strategies like call ladders, butterflys etc where the options lock in profit within certain prices (of the underlying), you ALWAYS cover just in case the underlying doesn't expire in that price range.

How much do you cover? Thats what the Delta is for. I assume you all know what delta is, but just in case, it's a statistic expressed as a %. If an options delta is 0.5 then your option is 50% likely to expire ITM. The option will increase by 0.5 ticks for each tick the underlying moves, and therefore, you should cover 50% of your options with a like number of futures/100's of shares. SO, if you have purchased 200 calls, you short 100 futures if the delta of the option was 0.5. If it was 0.25, you short 50 futures etc.

I wouldn't take this as word perfect. It's been a few years since I traded options professionally.
 

Rainmaker

Active member
201 3
Broker

I have not yet written covered calls on UK equities. I have experience of doing this on index futures, commodities, foreign stocks but not UK shares.

Can anyone recommend a good broker for doing this - one who has reasonable charges for the whole thing (buy/sell equities, options writing, etc).

Many thanks.
 

al-motor

Active member
249 0
Rainmaker- are u talking about a US broker ? if so, Optionxpesss.com seems to be ok. I am in the process of opening an account with them.

Al
 

Machiavelli

Newbie
6 0
I may suggest you Optures and Futions by Joe Ross. It is a very practical(!) book about combining options and futures in a way I have not seen in other option books. It also covers option writing strategies in detail.
I found this book very helpful for my trading.

machiavelli
 

JumpOff

1
702 14
Ouch! Just looked on Amazon and this book, "Trading Optures and Futions" by Joe Ross is listed at $195.00.
Does he have that much different to say than other sources of option information?
JO
 

Machiavelli

Newbie
6 0
In my opinion is Joe Ross one of the few real guys in this business. His approach to trading is always based on good commonsense and therefore practical. His books are well written and easy to understand. In fact they are among the best in my trading library. I have never regretted that I bought them. Other option trading books I know of are much more theoretical, and after reading them I found myself scratching my head and asking how can I get this information into trading action. For me it remained mostly nice to know, but, concerning trading, useless stuff. But be careful, that is only my personal opinion. I hope it helps.

machiavelli
 
 
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