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October 14, 2004
The Covered Call Trade Order
by John Brasher, CallWriter Publisher
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Consider a giant slalom
ski race: the number of fine and gross motor skills and movements
to be coordinated is immense. The winner is the one who does
the most number of things right. Writing covered calls is
just the same. The more sloppiness you eliminate, the better
it will go.
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Running the trade order is where the action begins. If you haven't
run a covered call before, don't fret over it. Running the trade
is easy as can be. But there are better (and not so good) ways of
doing it.
A covered call trade, like the giant slalom race, is not an act
but a series of acts. Each act is an opportunity to improve your
odds in the trade, or not. Good trading is about using discipline
and doing as many things right as possible. Today we look at entering
the trade order.
This article assumes that you are using an online broker. Obviously,
if you are using a live broker, just telephone the broker and provide
the trade details. But online trading is vastly cheaper, and you'll
find the execution is as good or better than using a live broker.
There are two ways to enter the trade order. The first is to leg
in, meaning to buy the stock and then (only once you're
dead sure you've bought the stock) sell the calls. The second is
to enter a net order, in which the stock is bought
and the calls sold simultaneously. The net order is either a net
debit (if it costs you money) or a net credit (if
you get more money than you pay). The covered call write always
generates a net debit, and closing a covered call trade always generates
a net credit.
Legging in is a poor way of entering orders and can lead to very
bad fills - - with technology where it is today, there is no reason
to leg in. Don't do it. Your trading will be better, because your
fills will be better, month in and month out by using net orders.
Go to the order execution page of your online stock broker. Virtually
all online brokers offer a custom order entry page
just for covered calls. In this day and age your broker should be
able to execute both the stock and option legs of the trade simultaneously.
Lets assume we are going to buy 500 shares of Cisco Systems (CSCO)
and write covered calls on them. We want to pay approximately $19.75
for the shares and sell the DEC $20 Calls for a premium of $1.20,
which would result in a net debit (the amount we
actually go out of pocket) of $18.55. We will enter a net
order that is $0.05 tighter than that, specifying a net
debit of only $18.60. The higher the net debit, the more the trade
is costing you. This order would be simply and easily entered as
shown below:
| Covered
Call Order Form |
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| Account
No. [
] |
Password:
[
] |
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| |
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| Stock Symbol: |
Quantity: |
Action: |
Price: |
| [ CSCO
] |
[ 500
] |
(•)
Buy |
( ) Market |
| |
|
( ) Sell |
( ) Limit
Net Credit [
] |
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(•)
Limit Net Debit [18.60
] |
| Option Symbol: |
Quantity: |
Action: |
|
| [ CYQLD
] |
[
5 ] |
(•)
Sell to Open |
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| |
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( ) Buy to
Close |
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| Duration: |
Advanced Order: |
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| (•)
Day Order |
(•)
None |
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| ( ) Good
until cancelled |
( ) Contingent
order |
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[Preview
Order] |
[Clear] |
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Example:
To run a covered call trade when the stock is 19.75 and
the 20 Call is selling for $1.20, the easiest practice
is to enter the order as a net debit of $18.55
(19.75 - 1.20). That way, even if the price of the stock and
option move, your order still will be filled if it can be filled
at the net debit entered. In order to make it more likely that
the order is filled, we specified a $18.60 net debit, meaning
we were willing to pay $0.05 more for the trade than the 18.55
net debit we were hoping for in the best case. The higher the
net debit, the more the trade is costing you.
We bought the stock and
sold the DEC 20 Calls to open. The order was entered as a day
order, meaning the order expires the same trading day if not
executed. How hard was that?
Trade
Tip. If your broker does not allow you to
enter a net order, change brokers! The last thing
you need to do is to buy the stock and then chase an order to
sell calls at an attractive price.
We could have
entered a market order, which instructs the brokerage to
buy the stock at the current market price (which will be the asked
price) and to sell the calls at the current market bid price. In
reality, the trade can go off at very different prices than those
shown when you put in the order. There can be orders ahead of yours,
and the stock or option prices can move before your order is filled.
We never use market orders to run a trade, and usually only employ
them when it is necessary to get out of an adverse trade quickly.
Caution:
No matter how you are finding your trades,
before hitting the Submit Trade button, double check
that the covered call you are selling is the one you intended to
sell. Option symbols are funny creatures, and there are some odd
ones out there due to splits, mergers and other activities.
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