Courtesy of Yodi
Covered Call Income Calculations
Calculations and explanations with respect to our member Randy's covered call (CCall) writing may be somewhat confusing. I further cannot agree to hold a stock for a month, sitting idle, while I am waiting in hopes that the stock will recover.
There are actually two ways I write CCalls, and I'll use JNJ as an example.
1. Buy the stock and sell an equal amount of calls against it, provided the stock offers more than a 3% dividend. (JNJ only pays 2.6%.)
2. Set up a leap BCS and sell ½ the amount of shorter month calls against it.
JNJ was trading at $122.71 on Friday, Feb 24. Randy chose two different months to sell his calls.
We first look at the March 17 position. As you will notice, JNJ has gone from another member’s $119.57 purchase price to $122.71. We'll base our calculation on the newer $122.71 price.
Let's say I sell the Mar 17 strike $123 call for $1.28. Return based on 100 shares of JNJ and 1 option is $128 x 100/$12,271 equals 1.04% / 20 days equals .052 x 30 days equals a return of 1.56% per month.
Let's say I sell the Jan 18 $125 strike call @ $5.33 and apply the same calculation: $533.00 x 100 / $12,271 = 4.34%. 4.34% over the course of about 11 months comes to about 0.39% per month.
Not going much further why would I sell a call for 4.34% and wait for 328 days, when I can get 1.04% in 20 days? You might say at the $125 strike price I could expect a capital gain on the stock of $2.29 x 100 or $229.00. But you could do the same monthly play for 11 more months, using the Jan 18 $125 strike call.
With the monthly play, three things can happen. 1) my CCall is ITM and my stock gets called away (if I do not roll) — I keep the $1.28 premium and give up my shares of JNJ for $1.23 per share. 2) The stock trades at expiration below $123 and I keep my shares plus the $1.28 per share premium. 3) If the monthly call expires, I can adjust my next month strike price in relation to the stock price and sell another call, and do this repeatedly.
In the above example I might add my cash outlay is $12,271.00 per 100 share(!), while I'm making a monthly return of 1 to 1.5%.
Now consider my play number 2.
Here I buy two leap BCS $110/125 Jan 19 strikes for $8.43 x 200 so my capital out lay is $1686.00, which at the same time is my max loss if the stock goes below $110. I personally reduce still my cost by selling two Jan 19 $105 strike puts for $5.40 x 200, reducing my capital outlay to $8.43 – $5.40 to 3.03 x 200 or $606.00.
Take in to consideration that the put sale cost you margin. I have taken in to consideration that the stock could drop by 14.5% and it still would be OTM at $105. So should the stock be just above $105 at expiration Jan 19 my total loss would be $606.00. (In the number one example, by purchasing the stock I would have lost $122.71 – $105.00 = $17.71 x 100 = $1,771.00 if the stock dropped to $105.)
By buying the $110/125 Jan 19 BCS, I expect the stock could go up at least $2.29 to $125.00. Here however I have capped the BCS with a maximum profit of $15.00 less my cash out lay of $3.03. So I am looking for a max. return of $11.97 x 200 = $2,394.00. This will give me a return of 395% over two years. Even if the stock stays at $122.00 at expiration date, I could still look for a return of around $1900.00.
With the above set up, I use the BCS just like a stock only with much reduced cash outlay and sell ½ monthly calls against it. By selling only ½ the amount of calls, I do not pay any extra margin, and the 2x BCS compensates to a certain amount when my short monthly call should run ITM. In this case again I have the choice to get out of the call or roll to the next month higher strike price. In the JNJ case I would look for the Mar 31, 2018 with a strike of $124 @ $1.17. This will give me some space to the upside. JNJ did have a good run up, but in today’s market conditions, we do not know what will be tweeted tomorrow.
Doing this only 15 times in the next 23 months will give me an extra return of $1.17x 100 x 15 = $1755.00 on my $606.00 dollar investment. Add this to the gain of the BCS $2,394.00 at a stock price of $125 or over, plus $1,755.00 equals $4,149.00 or 684%.
Which way to go is always your decision.
