This week’s Money NewsLetter for covered call writers discussed how to handle a stock that is pulling back to a clear support level, either a trendline or 50-day moving average - and noted how covered writers are free to trade the calls as the stock price moves around. What many covered call writers don’t realize when getting into the game is that we are not limited to selling calls once only!

Many stocks will oscillate in price, and when they pull back we can buy back the calls for less then we sold them - which creates a profit. Then when the stock moves back up, sell the call again. This is known as trading the calls and you can do this over and over. Look at the effect on your account, assuming you bought a stock for $20, wrote the 20 Call for $1.25, bought it back and wrote it again:

This is a simple example, but closing the call out at a lower price and reselling it when the call premium fattened up again on the stock’s snapback increased the return from 1.25 to 1.75, a 40% increase in the return. On stocks that move around a lot (swings of 1.00 to a few dollars intra-day or intra-week), the calls can sometimes be traded several times before expiration.

The amount that the call premium moves in comparison to a price move in the underlying stock is known as the delta. ATM calls have a delta of about 0.50, while OTM calls have a delta more like 0.30 (call premium would fall 0.30 if the stock fell 1.00). But ITM calls can have a delta of 1.00 or close to it, meaning that the ITM call’s price can fall dollar-for-dollar with the stock, or very nearly.

The covered call writer’s goal is to cream a stock for income by writing call options against it. The beauty of it is that we can trade those calls. Those who knock covered writing assume that we write a call and forget about it, themselves forgetting that covered call returns can be bolstered considerably by a little judicious trading.

This entry was posted on Wednesday, April 18th, 2007 at 3:51 pm and is filed under Covered Calls, Trading Tips. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.