WHEN DO I ROLL UP AND OUT?

September 30th, 2010

A subscriber has asked how I decide when to roll up a stock, or roll up and out.  I have set rules, although you can never eliminate changes based on good judgment at the time.  The basic rule is to decide if it’s a stock I want to keep, or let go.  I keep a stock if I would buy it at this time, otherwise I let it be called away.   Having decided that a stock is a keeper, when it gets just in the money, I try to find a way to roll up and out where the cost to buy back is the same as the new premium.  This happened with RIG this week.  Sometimes I cant find that.  If the cost to roll up is at least not greater than the initial (last) premium taken in, I often go with that.  If we can’t find that premium I re-evaluate how much I want to keep the stock, and if it’s like WAG this week, I might take a loss, buy back the option , and wait it out.

THINK ABOUT VOLATILITY

September 27th, 2010

If you are going to write options, you should understand volatility and its effect on option pricing. The first thing you should think about is that when we speak of volatility, we are referring to past history, and only inferring that the future might be the same as the past.  Now take a stock like BP: it had a high volatility rating (about 60%) before the oil spill, but nothing like the change in pricing since that event.  So always remember that surprising events can affect volatility, which is why we always hedge.

The greater the volatility of a stock, the higher the option premiums are, but the more likely you are to go outside of your predicted range.  So writing options requires good judgment of how much volatility to accept versus how much premium you can get.

The volatility rating of the S&P 500, or the “SPY” is 24%, which is a good number to stick with.  You can find the volatility ratings on listed stocks in many places, including Yahoo Finance.

I like writing calls and puts on ETF’s rather than individual stocks, because the volatility numbers are usually low.  I pick the ETF’s that are based on a group of stocks, and then if there is an event such as the BP disaster (really a buying opportunity) the one stock doesn’t have too much impact on the ETF price.

When Gold peaks, in my judgment, I sell calls on GLD.  When commodities are high I sell calls on MOO and GRU. When I think these ETF’s are low, or moving up, I buy them to write calls against later, after they move.

I PICKED A LOSER BUT AM COMING OUT OK

September 23rd, 2010

Walgreen (WAG) has been a disappointing stock.  I paid $34 for it sometime last year, and now it’s just under $30.  The statistics look good, and I keep thinking it will break out soon and get back into the $40 range that I think represents its true value.  It makes for a good example of why options are helpful even when you’ve picked a loser.

WAG  pays a 2.4% dividend, which isn’t much of a return, but will provide about $600 this year.  So since mid year, when I saw it wasn’t moving up, I’ve been writing calls against the stock. So far I’ve written calls three times, 10 calls each time, against the 1000 shares of stock I hold.

In Oct 2009 I sold 10 January calls against the 1000 shares of stock that I bought at $34 per share.  I took in about $1,100. These calls expired on January 19th, so the full premium became a profit this year.

In May 2010 I sold the Oct 39 calls and took in $1,054. The stock dropped and in June I bought back the options for $.03 ($55).  So I made another $1,000.

In July I sold 10 Oct calls again with a $30 strike price, and took in $915. With the stock now at $29 this is an open issue, and I might have to roll up.

The stock has dropped $4 since I bought it, for a $4,000 unrealized loss.  But during the year I’ve taken in $2,700 in realized gains, and $900 in my pocket but still an open question.  The point is that I’ve made a nice return on my money so far even though the stock has gone down, so I can afford to keep the stock (which I am still bullish on) while I live well on the premium and dividend income.  It sure beats a bank CD at today’s’ rates!

I ROLLED UP RIG

September 16th, 2010

As expected, today I bought back the November Rig 57.50 calls for $5,750, and sold the January 65 calls for $3,450, giving back $2,300 of the $2,900 I original took in.  So I am still $600 ahead, but now I am starting to also make a profit on the price of the stock.  Keep tuned.  I still think this stock is good to go up to $70 or more.   mlh

OPTION WRITING IS LIKE RUNNING A LIFE INSURANCE COMPANY

September 12th, 2010

Playing the options market is a lot like being in the life insurance business.  Think how you would feel if you just started your company and had written ten life policies on 10 people.  Now you are walking down the street and you see one of your insureds hit by a car and taken to the hospital.    If he lives you get to keep the premium he paid.  If he dies you have to pay out the face amount of the policy.  Next a flu epidemic strikes. All of the people are sure to die.  The only question is when.

You can only make a profit by playing the odds, and collecting enough premium income to cover the amounts you have to pay out.  Meanwhile you remain always at risk of an unexpected event during which an unexpected combination of deaths takes away all your liquidity.

Hey–that’s just like sitting on a bunch of naked puts, covered calls and call spreads!  This week I feel a bit like the guy described in the last paragraph. Here is why:

1.     I am short TEVA at 55.  The stock is 54.15.  I could let it go at a profit if it goes over 55, but TEVA is a strong company and I would like to stay in it for a while.  To do that I will have to take a loss on my 55 calls and roll up.  Stay tuned.

2.    I am short WAG at 30.  The stock is at 29.  While the stock has failed to perform as I had expected, I still feel that it is a good hold so I am in the same position as with TEVA.

3.    AAPL is at 263. That’s good news for me, since I have a put spread and if it ends up in Oct over 260 I get to keep a $10,000 premium.  But have you noticed how volatile the stock has been?

4.    COST is at $59.54, and I am short the 60’s.  I probably will let it go if it goes over 60, and take my profits.  I’ve written calls against it at least 6 times.

5.    MDT is at $33.34, and I’m short the 34’s.  This is another stock that has not performed well, but it’s a good company.  My cost is about $40, but if I let it go at 34, with the option premiums I’ve received over the past year, I will be about even.  I haven’t yet decided what to do with this position.

6.    RIG has been my strongest recommendation lately.  My cost is $57.50 on a buy-write, and I’m short the $57.50 calls which I wrote when the stock was down.  I will clearly roll this up as, in my opinion, this stock has a long way to go up.  I probably will hold this stock for a while without writing calls on it.

So you see why my stock positions are like life insurance customers on the verge of death.  But, like the insurance companies get out of the problem by just selling more insurance, we do the same by taking profits little by little, bringing in more and more premium income, and rolling the good positions up and out.  For explanations of these terms and strategies be sure to look at our tutorials.   mlh

KEEPING UP

September 2nd, 2010

Before leaving for a few days vacation, I’m checking my regular positions that provide me with a nice regular income.  On Aug 26th I sold 10 calls on my Medtronic stock (MDT).  My stock is still below what I paid for it, during a high period, but I’m way ahead by continuing to sell these calls on a regular basis, and I still have confidence that the stock will come back next year.  I received $905 for the Nov 34 calls.  The stock is now about $32.50, so I have to watch it, and roll up if the stock goes to 34.

As usual during periods of weakness in the market, I continue to write a bearish call spread every few months.  On August 23 I bought the March 125 SPY at $1.32 to hedge, and sold the Dec 117 for premium.  I paid out $1,375 for the March position, and received $1,615 for the December position, so I’ve got about $240 in my pocket.  If the S&P index doesn’t run up past 117, in December I’ll write another call and take in another $1,500 or so, maybe more, then start over again in March.  With virtually no investment this activity earns about $5,000 a year or so on average, with very little work on my part.  Of course, when I mis-guess and the market surges, I don’t do as well.

Aren’t options wonderful?