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Finance & Stock Groups Forum Index » Financial Planning » Covered Call Strategy... makes sense?
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| Shhhh |
 Posted: Mon Aug 25, 2008 1:05 pm |
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Guest
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Hello all... I found this strategy on another BAC forum. The author
claims it is a way to collect dividends and avoid downside risk. Seems
too good to be true, I'm sure I'm missing something... any thoughts? I
simply copied and pasted it below.
"Similar... take say $10G... look at the Jan2010 LEAPS.
Put on a covered call position current price $30.21
2.50 Strike $27.5
Putting this covered call on will make your effective average price
$2.71 (basically you are protected from everything except nuclear
holocaust)
Now that $10,000 will get you 3700 shares.
because of the wide spread in the 2010LEAPS.... assume this covered
call will result in a $21 per 100 loss. so with 3700 shares its a
$777
loss.
BAC will pay 6 dividends between now and january 2010.
3700 shares * 0.64 dividend = $2368
September Div: $2368
December Div: $2368
March 09 Div: $2368
June 09 Div: $2368
September 09 Div: $2368
December 09 Div: $2368
Total Dividends recieved: $14,208
Total Loss on Covered Call: ($777)
Total Profit on $10,000 Investment: $13,431
A little long winded I'm sorry, but I've been doing with with high
div
stocks for years... and it's a great strat.
"
Thank you all for help in understanding!
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| dapperdobbs |
| Posted: Mon Aug 25, 2008 3:49 pm |
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Guest
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{snip]
Shhhh,
I'll take a shot at it. Assuming you did the math and understand it,
there are a couple of points:
1) He's using rounded numbers - you need a bit more that $10,000,
first to cover the rounding up he used, and second to cover the
commissions. There's also the little matter that to actually implement
that, (I've never tried it) you'd have to find a broker who would do
it, since basically you are 'moving through' an 11-to-1 margin
position. My guess is you would have to have some $60,000 in
purchasing power to margin the purchase of 3700 shares, then the same
day sell the calls for $27.50 each to replace the cash (less the
$10,000).
2) I think the main points to look at aside from the math are that
whoever bought the calls has a fairly strong economic incentive to
exercise them in order to collect the dividends. Since options are
randomly assigned, you're assuming that the buyers are sufficiently
asleep as to not notice the dividends, or they figure the dividend
will be cut or eliminated, or some other reason (possibly tax-related)
I haven't thought of, or some spread strategy the buyer implemented
that involves closing out the calls against an offsetting position.
Out of the money calls, there's no incentive to exercise. Slightly in
the money calls, you might get an exercise. With deep in the money
calls, your chances of exercise increase, especially if the dividend
is attractive.
3) I didn't check to see if the options pricing offered is correct or
not. Usually, you don't see calls that deep in the money - for some of
the logic given above (why not buy the stock and collect the
dividend?). The only ones I've seen that far away from the current
price were with a stock that had quintupled in the last 12 - 16
months.
4) If the stock dropped below $2.50 (say $2), you would be holding the
shares - unlikely, but by that time there would probably be no
dividend, and $2 x 3700 = $7,200, so you just eat the 30% loss on
your $10,000, commissions, etc..
In summary, I don't really think you would collect the first dividend
payment, and would simply lose the $777 (plus commissions). But
there's a lot I don't know. I'd trust your intuition about it.
(I think I got the thing right, above. I stick with simple stuff, like
buying 100 shares of XYZ at $30, then if it gets to $40, maybe selling
the $45 calls - provided I'm indifferent if it goes to $50 and gets
called away.)
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Misc.invest.financial-plan is a moderated newsgroup where Moderators strive
to keep the conversations on-topic for financial planning. Other posting
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which we respond. For all of the other tips and suggestions, see "FROM THE
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| John A. Weeks III |
| Posted: Mon Aug 25, 2008 5:00 pm |
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Guest
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In article
<e0d2d20e-d555-4bbc-ad88-7525148e0484@v57g2000hse.googlegroups.com>,
Shhhh <trumpet1120@comcast.net> wrote:
Quote: Hello all... I found this strategy on another BAC forum. The author
claims it is a way to collect dividends and avoid downside risk. Seems
too good to be true, I'm sure I'm missing something... any thoughts? I
simply copied and pasted it below.
A little long winded I'm sorry, but I've been doing with with high
div stocks for years... and it's a great strat.
This is the old Wade Cook strategy #1. This is one of those
deals that works great on paper, but fails in the real world.
The reasons are that the example doesn't include commissions,
nor does it account for typical volatility. The problem is that
the stock prices vary widely enough any given week that the
market is likely to go up or down far enough that you will
get called out, and the commissions to get your stock back
will cancel out anything you make on the option. Even Wade
Cook lost his pants doing this stuff, so be careful.
-john-
--
======================================================================
John A. Weeks III 612-720-2854 john@johnweeks.com
Newave Communications http://www.johnweeks.com
======================================================================
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Misc.invest.financial-plan is a moderated newsgroup where Moderators strive
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| joetaxpayer |
| Posted: Tue Aug 26, 2008 5:59 am |
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Guest
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Shhhh wrote:
Quote: Put on a covered call position current price $30.21
2.50 Strike $27.5
When an option is that deep in the money, it's often called away. i.e.
you find yourself with cash instead of the shares. And it often happens
just before the dividend is declared.
I suggest you look at the options tables and study the activity of a few
(dividend paying) stock's strikes which are deep in the money.
I had the same idea with MO some time back. I watched the open interest
drop like a rock the day before the stock went ex-div. Meaning the
options holders exercised their right to buy the stock, and pay you the
remaining $5 or whatever to own the stock and not the option.
Joe
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Misc.invest.financial-plan is a moderated newsgroup where Moderators strive
to keep the conversations on-topic for financial planning. Other posting
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