Next-Generation Lists

• What is a SuperPut?
• A SuperPut Trade Illustrated
• The 7 Reasons to Write SuperPuts
• SuperPut Trade Selection
• Basic SuperPut Management

The Covered Call

CallWriter's family of SuperPut lists presents something new in covered call lists: covered call trade candidates with a long-dated protective put added to protect the stock's downside. The covered call trade is built like this:

The covered call is one of the most popular option-based strategies of all time, because it is simple, profitable and conservative. But no matter how conservatively we approach the covered call, the stock could sell of, handing us an ugly loss.

Is there something with the income potential of a covered call but even more conservative? Yes, there is, and we not only offer the strategy but a family of lists for it. Meet the Superput...

What is a SuperPut?

Because the covered call involves a long stock position, the danger posed to the writer is a sell-off in the stock. The best protective measure to define and limit risk in a covered call trade is to buy a long-term protective put when the trade is placed (known as a married put when the put is bought at inception), which I refer to as a SuperPut trade. The SuperPut position looks like this:

This is not complicated, since the SuperPut is a calendar collar, which means a covered call position protected by a long put with an expiration much further out in time than the call being sold. So always think of the SuperPut this way:

Recall that a put option gives its holder (in this case, you - the call writer) the right but not the obligation, to sell the stock at a fixed price for a specified period of time. Thus even if the stock price collapses, the call writer who has purchased a protective put will be able, for the life of the put, to sell the stock at the put's strike price. In the CallWriter SuperPut trade, the long puts shown on the list will have an expiration that is six to eight months out.

Why do I call it the SuperPut? Because the trade involves a long put that does a super job of protecting the underlying stock. These trades really are SuperPuts. We also refer to them as Protected Buy-Write (PBW) trades.

Here is the position's rationale:

* We insure the position, with a small deductible;

* While retaining the ability to bring in income.

SuperPut trades are constructed to provide cheap protection for your stock over the intermediate term, while allowing you to write calls every month to bring in a stream of premium over time. Additional profits can be realized by trading the calls. The advantages of the SuperPut trade - when the long-term put's cost is cheap in comparison to the current-month call's premium - are numerous.

The SuperPut Illustrated

OK, let's build a SuperPut trade with Nucor Steel (NUE):

Nucor SuperPut Example
Buy Nucor stock - NUE	29.00	2,900.00	Cost of asset
Buy 8-mo. $30 Put	4.60	460.00	Insurance premium
Sell current $30 Call	2.00	200.00	Asset income
Net Debit (cost basis)	31.60	3,160.00	Asset + insurance
Price Guarantee	30.00	3,000.00	Insurance payout
Maximum Risk - 5.1%	1.60	160.00	Deductible

In this example - a real trade - the put cost a little more than 2x the premium received. However, the $30 put's price guarantee limited our loss in the position to $1.60, or 5% of our capital at work. We call this amount actually risked the SuperPut deductible.

One way to recoup the deductible is to sell the put after call expiration, whether we are called out of the stock or still own it.

The Time SuperPut

Another approach to the Superput position is to keep writing calls each month, under the long put's protective umbrella. This works best when the stock is flattish or gently rising. The following Baxter International (BAX) SuperPut trade illustrates this approach. Though the table looks complex at a glance, it really isn't. Here are the assumptions:

• We buy BAX stock for $54.83 in September 2009
• We buy a $55 protective put with an expiration in April 2009 - cost $6.70
• We sell a September 2009 $55 call - premium $3.20
• For the life of the put, we continue selling calls - for a total of 8 months

The trade costs us $58.33 per share to put on (54.83 - 3.20 + 6.70), or $29,165 if we bought 500 shares. Because premium for subsequent months may not be so high, I've assumed lower premium of $2.00 for months 2-8.

SuperPut Trade Example - Baxter Int'l (BAX)
Month	(1)	(2)	(3)	(4)	(5)	(6)	(7)	(8)
Stock = $54.83	SEP 55 Call	OCT 55 Call	NOV 55 Call	DEC 55 Call	JAN 55 Call	FEB 55 Call	MAR 55 Call	APR 55 Call
	Jan-08 55 Put
Buy stock	54.83
Write calls	3.20	2.00	2.00	2.00	2.00	2.00	2.00	2.00
Buy Jan 55 put	6.70
Net Debit	58.33	56.33	54.33	52.33	50.33	48.33	46.33	44.33
Premium Stream	3.20	2.00	4.00	6.00	8.00	10.00	12.00	14.00
Return on Original Trade Debit (58.33)	5.5%	8.9%	12.3%	15.8%	19.2%	22.6%	26.1%	29.5%
Maximum Risk (Net Debit - 55.00 strike)	- 3.33 (5.7%)	- 1.33 (2.3%)	+ 0.67 $335.00	+ 2.67 $1,335.00	+ 4.67 $2,335.00	+ 6.67 $3,335.00	+ 8.67 $4,335.00	+ 10.67 $5,335.00
Note that computations do not take trade commissions into account.

Assuming we got the premium stream shown, here is our result:

• We brought in $14 in total premium after the first call write in Sept.
• We reduced our cost basis to $44.33
• The total return for the 8 months was 29.5%
• In November, we recouped the deductible - it's now a riskless trade

While we cannot know what the stream of call premium will be, we have fixed the cost of put protection going in. We have also defined and fixed our maximum risk at $3.33 (5.7%) on trade entry. Isn't it nice to know that you can make money on a SuperPut trade and never risk more than a small amount?

The 7 Reasons to Write SuperPuts

1.	Call-Writing Income:
The long-term put gives you 6-8 months of time to generate income.
2.	Call-Trading Income:
The put-guaranteed price frees you up to close and rewrite calls to supercharge income!
3.	The Stock is Insured:
You insure everything else, subject to a deductible. Why not your covered calls, too?
4.	The Long Puts are Dirt-Cheap:
Unless deeply ITM, the long puts on our SuperPut lists usuallycost only 2x to 3x the current-month call premium. And you can instantly look at other put strikes.
5.	Great on Volatile Stocks:
Volatile stock = high premium. They're not very scary with SuperPut protection.
6.	Makess the Downside Stock Risk Someone Else's Problem:
What more is there to say?
7.	The Trade Soon Becomes Riskless:
Once the put's cost has been recouped (the deductible), the trade becomes riskless.

Now it is time to see what the excitement is all about! We will select a sample trade that in early September 2007, as this is written, offers good prospects as a SuperPut position.

SuperPut Trade Selection

A stock with a medium-to-high level of of volatility makes the best SuperPut candidate if you are planning a time SuperPut - we want some assurance that the call premium will continue to be good.

The SuperPut (and covered call) writer essentially is milking the stock for call premium. And just as the dairy farmer prefers, for the same cost, a cow that gives lots of milk to one that gives little milk, we should look for stocks more likely to produce call premium. The two primary factors that make money for a SuperPut writer are:

1.	*Consistently higher-than-normal* levels of implied volatility.**
Implied volatility (IV) is an expectation that the stock may move - become volatile - in the future. It is usually caused by a pending event, like earnings or due to general uncertainty (think GM). This scenario is not so great for a time SuperPut, because the high premium will evaporate if the spike in implied volatility disappears.
2.	Actual volatility in the stock.
Stocks with a historical volatility of about 40% or more can make excellent SuperPuts. I usually don't touch anything over 80% A stock packing some volatility is a necessity for a time SuperPut.

Basic SuperPut Management

Here are some common scenarios and basic trade adjustments:

1.	The stock drops in price.
Close (buy back) the short call if it can be repurchased for half its selling price, or less. This will increase cost basis slightly. Our plan is to rewrite the call when the stock recovers. This leads to much higher returns. We use this technique when the stock pulls back (e.g., the market is pulling back briefly or the stock is pulling back on good earnings news), not when the stock or market is in serious trouble.
2.	The stock appears to be selling off.
Bad news for the stock, or the market or industry is selling off. Close the short calls, sell the stock, but keep the put. When the stock has dropped further, either sell the put or buy the stock again and exercise the put. Put in an order to buy the stock again in case it rises instead of continuing to fall.
3.	The stock remains essentially flat.
The ideal SuperPut - keep creaming it every month for additional call premium.
4.	Call premium goes flat.
This can happen when you pick a stock that is not normally very volatile and therefore usually has low premium. Once the volatility spike is over, so is the fat premium.If you cannot get a monthly premium equal to the average put cost per month, close the position.
5.	The stock goes up.
Some writers prefer to roll the calls up or up-and-out (buy back the short calls and sell a call with a higher strike price), which increases the potential profit in the trade - but also increases your debit - and risk - in the trade. Instead of increasing your stock basis, consider buying a call to participate in the stock's rise, or create synthetic stock by purchasing the call and selling an OTM naked put. An OTM bull put spread also works (below a support level).