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OP SmartWrite is a Covered Calls focused portfolio whose focus is to build wealth. The key objective of this portfolio was to develop an approach that can withstand almost any market moves and still generate a positive alpha vs simply buying-n-holding a basket of stocks. As I mentioned when we opened the portfolio in October that it is probably the worst time to open covered call or Buy Write positions as implied volatility is low and markets are rallying like never before.

Since then, even after including recent pullback, S&P 500 is up +5.95% (since Oct 2nd start of the portfolio) and SmartWrite’s benchmark The BuyWrite Index ($BXM) is up +5.19% !!!

So how did OP’s SmartWrite Portfolio perform, here is the snapshot:

1. SmartWrite is up +7.3% vs +5.19% (BuyWrite) and vs +5.95% (S&P500).

2. We started with 10 underlying, choosing highly liquid stocks in such a way that it can be scaled to hundreds of millions of dollars!!!
3. There was only 1 change in underlying assets during 4 months of holding period!!
4. Trading was limited to just a few times per month (except for rolling weekly hedges).
5. We didn’t place any major hedge for individual stocks. But instead, hedged the whole portfolio (Using VIX and SPYs).
6. No individual hedge was placed before earnings announcement of an individual company.

Bottom-line: With little trading activity, the portfolio has generated almost 200bps alpha over the benchmark BuyWrite index as of  Jan 28th closing. We will continue with the experiments and learn more as markets might be starting to pullback. A severe market pullback or any single company going bust will be key tests of the strength of this portfolio.

Should you have any questions, or if there is any way I could help you in turning around your trading, let me know via writing an e-mail to -> Ask@OptionPundit.com

 

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MEMBERSHIP IS NOW CLOSED

 

Writing Covered call is one of the oldest and simplest option trading strategy. There are hundreds of websites both paid and free. There are hundreds of screeners (if not thousands). In fact, many funds are being created which utilizes Covered Call strategy and they benchmark performance against BXM (the CBOE’s buywrite index).  Based on recent research, total growth for indexes since mid-1986 was 830% for BXM Index, 807% for S&P 500 Index. Albeit, hardly few traders are consistently able to outperform BXM or S&P500.

If you are wondering what covered call is, it is as simple as –

1. Buy Stock
2. Sell Call
3. Wait, watch, Monitor, collect income
4. Rinse, repeat the process next month

Though it is easier, you may want to check out my earlier post (Part-1) for do’s and don’ts. I shall be introducing more articles on that in the coming weeks. After waiting for almost 5 years, I am now starting a covered call specific idea newsletter.  Why now?

As you may know covered call strategy will outperform buy-n-hold strategy  –

1. In sideways markets
2. In downward markets
3. In slowly upward trending markets

Where it doesn’t outperform is the fast and furious rallies like the one we experienced since debt ceiling alignments. Thus IMHO, this is probably one of the worst times to start covered call process because-

1. Stock market is bubbling with Euphoria. There is hardly any fear and markets are making all time high, day after day thus there is hardly any value left.
2. Implied volatilities are amongst the lowest level thus income yields are amongst the lowest level.

I am taking up this challenge to weave an approach that is aimed at outperforming BXM utilizing a $100,000 model portfolio. Though it is a passive trading approach mostly, I plan to manage it dynamically. So far my passive approach alone has delivered +23% for the year (net after commissions) far outperforming the BXM index and slightly ahead of S&P500. Here are more details about SmartWrite

Objective: Outperform BXM on Annual Basis

Trading Approach: Long term, passive. Yield Enhancement. Investing vs. Trading.

Who is it for:

• Those who are looking to for a simpler strategy to generate additional income yield
• Buy and hold investors who want to generate additional income from their shares
• Those who are looking to learn from a real-time experiment

You will have immediate access to all the trades (started only On Oct 2 2013). It’s ACTIVE LEARNING i.e. hands-on training vs. a traditional class room set-up.

Who is it NOT for:

• Someone who is looking for trading ideas everyday
• Who is looking for get-rich-quick trades

It was only open to OPN Members since Oct 2. Now it is opened to all the OP readers. If you would like to join, pls click at the sign-up button on the right. The seats are limited and will be closed on November 03, 2013.  The cost only $49/month [Paid as one time $294 for a six month access].

Here are some generic questions. Should you have more questions, please post in the comments section-

Here are some FAQs-
Question- This will be owning stock in something and selling OTM calls against it, correct?
Yes and some more e.g. protecting it as well based on my directional/non-directional view.

Question- Which instrument will you use?
Multiple but mostly the companies that I would like to own. Basic principle- I am buying stocks and then writing covered call vs buying stocks to write covered call.

Question – What would be your goals (ROI, Learning) for six months?
To outperform BXM, the buywrite index (and stretch target will be to outperform S&P500 as well)

Question- How many trades per month?
I have selected a portfolio of 10 underlying, so at best 10 trades/month (mostly rolling calls) in worst case, probably double roughly.

Question- Are we going to learn how to select underlying and entry/exit criteria?
Yes. That’s the whole point of inviting only a few friends. But it will not be as frequent as OPN. Once we have set-up the trade, we want it to be as boring as possible.

Question- Is the strategy limited to covered calls or will you compare it with other strategies like selling naked calls?
No naked calls. You may compare with naked put selling (as it is same selling covered call) but that’s not really the objective. The idea is to have a portfolio that is designed to generate better yields. It is not a trader’s portfolio. It is more of an investor’s kind of portfolio.

The journey begins now,

Profitable trading, OP

Covered call option trading strategy is probably the oldest and most popular trading strategy involving stock and an option. Usually, it is one of the first option trading strategies that a beginner option trader learns when transitioning from stocks to options. The attraction of simplicity lures investors and traders alike thinking they have found a holy grail of successful investing and they can now beat the market.

Before proceeding further, Let me first explain what a covered call-is

1. Buy Stock
2. Sell Call to collect income
3. Wait to let it expire or adjust

As simple as that!

Here is how a risk reward chart looks like.

There is no easy money! Let’s be clear about that. Successful investing requires hard and smart work.

So before you jump into covered call writing, here are a few things you need to understand well:

1. Buy stock (easy part); which stock (hard part)?
2. Sell Call: There are hundreds of call options, which call option should you sell? And why?
3. Wait & watch: The stock goes above the strike you sold, or continue to drop wiping out the protection you thought you had by selling the call. And during the process you are scared by the losses that you decide to sell stock and buy back call…to see it all come back….

Recently an OP reader asked me this question-

But when I try to write covered calls, not those stocks but others, I am not doing so well. I guess I write covered calls when a long position has moved against me. I look at the chart, I say no problem, that’s going down, it’s $7.47. I’ll write the $8 call 6-8 weeks out … and while the stock drops to $6.88 short term, it’s happened more than once that in the last week of the option the stock zooms over 8 – temporarily –
but just enough to force me to either give up the stock or buy the option back.

So is my problem reading charts 2 months in advance, or writing calls when
panicked over being underwater in a stock?

The real question: how do you decide where, when, how long to write a covered call?

This is a very common issue.

The primary objective behind the covered call strategy is to generate additional income or provide defined protection. And in order to achieve one goal, you will have to trade-off another. But whether you are generating an income or defining protection, you are doing so for an underlying asset (e.g. stock) which is your long term holding.

Let me give you a simpler analogy-

You purchased a house that you think will appreciate over a period of time. Now you are renting this house to generate additional income along the way. However, if you bought the house at wrong time, you might still suffer a capital loss and yield may not justify the principle loss. But if you purchased the house with a very long term view and at right valuation (i.e. think margin of safety), the net yield might still provide cushion during bad times.

Stocks are priced more frequently than houses. Everyday pricing weakens our emotions. It’s easy to find daily, hourly charts for stocks but not for house. Thus, we take short term view on stock while longer term on house.

So the question you may want to evaluate is this-

Is my stock investment a long term holding? And Did I pay the correct price?

If the answer to two is Yes, over the “long run” stock value will materialize while generating additional income from covered call.

Don’t simply trade covered call strategy just because it is cool to do so, or just because IVs are high and calls are providing you good premium. Do it so after evaluating whether or not you would want particular underlying to be your long term holding and are you paying the right price for your long term holding?

In the next part, I shall explain some criteria that you may want to keep handy while evaluating covered call strategy. This will include which strike? What kind of stock? Etc.  Part-3 will explain about protection and some adjustment strategies. You may want to stay connected via twitter, facebook or simply join our mailing list (right side bar).

If you are trading covered call and you have questions that you would like to be addressed, please mail those to me -> Ask@OptionPundit.com and I shall be glad to answer those.

Profitable Trading, OP