Option charges

[osho67]

Yesterday for the first time I did a covered call option on IB. Will you believe these charges. To buy 100 stock it cost $1 and no stamp duty. To sell one option it again cost $1 as compared to £22.5 plus contract fee of £1.8 with a uk stockbroker.

Because of the low charges the return will be about 14%

This is not a recommendation to sell options. Just to highlight the charges in UK. And the option spread was very narrow as well.

 

[JonnyT]

You may make a negative return. What you are saying is that your maximum return is 14%.

Most covered call writers lose out long term.

JonnyT

 

[osho67]

Dear Jonny

Yes I agree this is a potential outcome. I try to select very low volatility shares Over the last 10 years I have lost out only on one share which was Polypeck.

Premium received on covered call is classified as capital gain and this strategy has helped me to use my CGT allowances.

Please suggest if you have some other way . Thanks for your valuable comment

 

[JonnyT]

Ho Osho,

I take it you are trading US Stocks hence no Stamp etc?

Good luck with the strategy, but you still need the underlying not to fall, in fact ideally stay still so you can keep repeating the process. Do any shares actually do this?

JonnyT

 

[osho67]

Hi Jonny

Yes I have traded on us stock. Spreads are very low.

But you have made me to think and I am going to look to this possibility when markets open.

What I can do is to sell a put option and buy another put at a lwer price which will result in small net credit. This way I am protected to sell shares at a certain price limiting my losses.

If the share price goes up my original call will be exercised. and my shares will be sold making me another profit equal to the selling price minus the buying price. Selling price is fixed so upside potential is limited.

 

[RogerM]

In my view selling calls against stocks you hold (i.e. a covered call) is actually lower risk than just swing trading the shares on their own. Most people get hung up on what happens if the share price rises above the strike level of the short call. But it's no drama - you have just capped your gain at this level. The risk to capital is that the share price falls, but at least in this case you still get to keep the call premium to offset against the loss made on the shares.

Care to share with us what the trade is osho67?

 

[osho67]

Thanks Roger (M0 for your support.The trade was on Microsoft. The expiry is Jan 04 and strike price is $30. The buying price for shares was about $28.5. I received a premium of $125. I have traded only one contract.

Your opinion on another matter would be much appreciated. Will it be good to trade call option on us indices? Please tell me what are the ticker symbols for Dow, S&P and Nasdaq.

In UK the expiry months are 3, 6, and 9 months. I donot understand how it works in US.
Thanks for any comments

 

[JonnyT]

Hi Osho67,

I make that a return of 4.38% assuming you are not taken out and the price doesn't move.

If you are taken out I make it a return just below 10%

Is this correct?

Thanks

JonnyT

 

[osho67]

Dear Jonny

What will be annual return? My position expires Jan 04

 

[JonnyT]

Hi Osho < 10% as you cannot assume that you will be taken out and the process will be repeated 4 times per annum.

JonnyT

 

[osho67]

Hi Jonny

I am sorry I donot understand you. I have received the premium which is not refunded. The premium alone is more than 10%

I have bought the shares at $28.5 and I have sold the option at $30. If I am exercised I will make another $1.5 per share i.e.$150. If I am not exercised the shares are mine and I can sell another option in Jan 04. Why cant the process be repeated 4 times a year?

 

[Jimbo]

Stock selection is important with covered calls as you are normally at risk from a collapse of the stock price.
There are a number of strategies that can be used to minimise the risk.
I have been using IB and there seems to be an interesting difference to brokers that I have used previously.
The written call does not appear to be linked to the stock in the same rigid way that I have been used to.
This means that you can have a stop loss on the stock for protection. Of course if the stop is hit your margin position would change and the call would be naked. But except in extreme cases you would be able to buy back the call for a profit.

I would be interested to hear the views of the experienced options traders on “covered” calls with a stop loss on the stock.

 

[JonnyT]

Hi Osho,

$125 isn't 10% of $2850 is it? Am I missing something?

JonnyT

 

[osho67]

Hi Jonny

May be I am not good at maths. I have earned $125 on an investment of 2850 for a period ending Jan 04. I roughly take this as 4 months. So 125 divided by 2850 multiplied by 100 gives me 4.38 and to annualise that I take 4.38 divide by 4 and X 12gives me 13.14% per annum.

Please tell me what am i doing wrong.

 

[stevet]

jimbo - writing a covered call really needs to be done at the right time and at the right price - and its a great strategy if u have the experience to then trade in and out of the option in order to lock away little profits to save up for when the occasional stock tanks !

but remember there are lots of people who spend their whole day looking to take a stock to where they know most people have put the stops - which is why stocks tank and then bounce - so its a tricky game to play - but if you are able to trade in and out of options and know the technicals of the stocks - it can be a one way ticket for a nice earner - and i am assuming you mean US stocks and options - i have no experience of European options - but from what i have seen, the odds are against you in Europe

 

[RogerM]

Guys - the way I see it is this.

osho67 has bought 100 shares of MSFT @ $28.50 for an outlay of $2850. Against these he/she has sold a single January 2004 $30 call contract and taken in premium of $125. He/she keeps this in all circumstances. Assuming that the share price of MSFT stays unchanged (or stays below $30), this call will expire worthless and osho67 keeps the $125 and repeats the process for April or July (MSFT options have series for Jan, April, Jul and Oct). The return applicable to the option premium in isolation is therefore (125/2850) x 100 = 4.39%. This has been achieved in 4 months, so the annualised return will be 4.39 x (12/4) = 13.17% per annum.

The return for the strategy as a whole will depend on what happens to the price of MSFT. The maximum profit possible will be if the price reaches $30. There will then be a gain in MSFT of $1.5 x 100 = $150. The percentage gain is therefore (150/2850) x 100 = 5.26% gained in 4 months. Annualised this is 5.26 x (12/4) = 15.79%.

Therefore the maximum annualised profit for the strategy is 13.17% (option premium) + 15.79% (share price increase) = 28.96%. In addition to this will be any dividends paid ( b***** all in the case of MSFT).

The attraction of this strategy is that even if the share price stagnates there is still 13.17% annual profit to had from the call
premium, the downside being that in the event of the price of MSFT running up thru $30 osho67 will not participate in any additional benefit because the shares will be called away at $30. If the share price falls $1.25 to $27.25 osho67 still breaks even because he/she keeps the option premium of $125 in all cases.

If the price of MSFT falls early on in the strategy then there is a decision to be made. If the shares are sold at a stoploss, then the calls are no longer covered. In the event of a runaway rally above $30 there would be a loss per share equal to the amount by which the price exceeds $30. Why? Because if the price went (say) to $36, osho67 would have to buy the shares at $36 in the market and hand them to the buyer of his option at $30, so creating a loss of $6 per share. Therefore if the shares are sold before expiry of the option, you need to decide whether to buy the calls back, which you should be able to do for a profit because the share price has fallen, plus time decay has worked in your favour, or hang on to them and carry the risk of the price rising above the strike price, in this case $30. You choose!

HTH

 

[RogerM]

A further thought! The important thing with selling covered calls is to ensure that they are covered! If instead of buying shares you buy a CFD, it will do the same job and the arithmatic is quite interesting.

In the MSFT example you should be able to buy CFDs for 100 shares on a 10% margin, in this case $285. Therefore the returns would be :-

For the option (125/285) x 100 x 12/4 = 131.58%.

Obviously the %age profit/loss for the CFD would also be exaggerated 10 fold as well, so care needs to be taken to cut losses quickly. But it does show, theoretically at least, how you can make a triple digit return even if price goes nowhere!

Just a thought!

 

[JonnyT]

Hi Roger,

I understood even before you posted

It isn't a guarenteed return, far from it. It is totally wrong to annualise a single covered call as it may or be not be repeatable.

I made 9.08% on my spreadbet account yesterday (actual fact), If I annualise it then my annual return is 598,373,267,974%

i.e. I'm richer than Bill gates a year from now.

JonnyT

 

[osho67]

Hi RogerM

Thanks so much for your input. I feel that there are many option traders on T2W but threads discussing options are not that many.

On CFD you have not mentioned the daily financing charge, which can eat away a big chunk

 

[RogerM]

JonnyT - there is no way that I would annualise a return based upon one day's spread betting, and especially not compund it. But I don't think it unreasonable to annualise a 4 month return and without any compounding. Unless options on MSFT are discontinued there will be an opportunity to repeat the process through the year. Current implied volatility is historically low, resulting in lower than average option premiums, so it may in fact be possible to sell calls in future at higher prices, and therefore at a higher potential profit, if implied volatility returns back to a historical norm.

I agree that the return of the entire strategy is not guaranteed because so much depends on the price of the underlying shares. That is why I was careful to state "Assuming that the share price of MSFT stays unchanged" in the explanation above. But what can offer a guaranteed return apart from deposits at 3%?

osho67 - fair comment re the daily financing charge for CFD's - it was just a thought to encourage debate. Not sure what the financing charge would be, but if (say) 5% p.a., a 100 share CFD on MSFT would require a charge of $2850 x 5% = $142.5, or 50% of the money used as margin, reducing the return outlined in my previous post from 131.58% to 81.58% annualised. And that is only based on the MSFT price stabilising and all the gain coming from the written calls. But hey! It was only a comment to stimulate debate!