Covered Call Strategy in my Traditional IRA Update

Earlier this year I decided to finally man up and put some money into an idea I have had for a while.  The basic idea is to purchase short term covered calls on near the money stocks that are inexpensive in terms of whole dollars so I can buy multiple contracts (an option contract is based on 100 shares).  The stocks I have been and would continue to buy first had to survive a pretty rigorous stock screener which is outlined below.  I am not providing financial or legal advise so please use this post only as a voyeur looking into some of my moves.

What is a Covered Call?

To understand what I am doing first you need to understand what a covered call is.  According to Investopedia a covered call is,

An options strategy whereby an investor holds a long position in an asset and writes (sells) call options on that same asset in an attempt to generate increased income from the asset. This is often employed when an investor has a short-term neutral view on the asset and for this reason hold the asset long and simultaneously have a short position via the option to generate income from the option premium

A covered call has no additional risk than just owning the stock in a normal manner.  I actually think it wouldn’t be a hard argument to make that it is less risky as you have actually received some of the money you invested back in cash.

Put a different way:

  • I own (at least) 100 shares of a company
  • I then sell a contract (1 contract = 100 shares) that says if the company reaches $X price (the strike price) by a certain time the purchaser gets the option to purchase the shares at that price.
  • When they are buying the contract they believe that the share is going to be worth more than that amount.
  • For creating/selling this contract I get a sales price.

Screening Stocks for Covered Calls in my Traditional IRA

I use the following screen options:

  • Market Capitalization is Greater than or Equal to $200mil
  • P/E is in the range of 1 to 20 – I want only profitable but not highly valued companies
  • Options are offered – Some stocks are not on the options exchange
  • Security Price is less than or equal to $5 – As you will see below I need the stock price low since I have to buy 100 shares per contract and I am usually doing multiple contracts.
  • Security Deposit is not a Depository receipt

I have provided updates a couple times this year it seems that this screen usually provides me with about 30 (sometimes its 28 and sometimes it is 34) stocks.  I then look up every single stock and determine whether:

  1. Is the underlying equity near an in the money strike? Depending on the exchange the stock is on there might only be strikes at certain intervals ($2.50, $5, $7.50) or there may be strikes at every single dollar.  If you have a $3/share stock and the next strike is $5 I don’t believe I am picking the next winner that is going up 70% within 6 months.  If I could do that I wouldn’t have to work lol
  2. Does the underlying equity have a healthy option exchange.  There are situations where we could meet the above screen, and even be near the money, but no one is trading the option so who am I going to sell a contract to?
  3. Is the stock a Chinese Company? The above stock screener provided 5 or 6 companies that were wholly owned and operated Chinese companies but trading on our exchange.  For some reason I just feel like this is not the area I should get my foreign exposure.  We will leave that to my 401(K) and through my dividend paying stocks that operate over there.

Looking at each stock doesn’t take that long.

How I have Done with this Investment Strategy Since my Last Update

I had an excellent conversation with W at Off Road Finance about what is “Done” meaning am I calculating losses and gains on the actual option contracts, and to be truthful, it may be a terrible way to look at it, but I am solely looking at account value and trade profit.

If you would like details starting from the beginning please check out my Tracking Traditional IRA Page which I constantly update or any of the individual post updates, but below are the moves made since my August Update:

NSU

  • Bought 500 Shares of NSU at $4.54 plus commissions for a total of $2,280.30
  • Sold 5 December $5 contracts for $.50 minus commissions I received net $238.14
  • As of the post date the equity jumped .30 cents to $4.88
  • If it closes at $5 my gain will be just shy of 20% inside a few months ($2,492.05 + $238.14 – $2,280.30)

RDN

  • I had successfully navigated this equity with multiple contracts being opened and closed but I was left with 300 shares of RDN left over from my August Update.
  • I had thought about selling more contracts, but from the time between my update and when I actually paid attention to the account the value SPIKED from just under $3.50 since that was my last option contract that didn’t get called to $4.87!
  • Decided against it since the options market for this equity didn’t seem that interested in selling $5 calls (volume was low).  I could have waited but after that type of gain I walked.
  • Closed out on $1,453.01

EXM

  • September $2 strike was no where near met as the stock was/is measured in dimes lol
  • I am sitting a thousand shares with a basis at $1.88 a share
  • I sold 2 expired contracts worth about $378.
  • Once there is a market for the stock I will sell a $1.00 call – that will bring me back to even…maybe

I haven’t made a move in a bit because I was waiting to write this post, but the cash to equities ratio in this account is just unacceptable and not discipline.

Stocks I am Looking at For the Covered Call Strategy

I am not comfortable saying I am buying X stock.  I don’t do it anywhere on the site, but here are the stocks I have whittled that list of 30 down to for a final judgment tomorrow:

  • MGIC
  • EXEL
  • NSU – I bought in at $4.54 and it is currently (as of this post) trading at $4.88 so that $5 call has a lot less upside
  • MTOR

Any opinions on my strategy or on the stocks chosen for the next few months to watch?

3 Responses to Covered Call Strategy in my Traditional IRA Update

  1. I haven’t ventured into covered calls or other derivatives, but I probably will some day down the road. Thanks for the overview and explaining your method for picking companies.

  2. Cash Flow Mantra says:

    Unfortunately, EXM is dead money for a while, but assuming the company is stable you could do a little averaging down. I would only do so if the company will survive. Otherwise, it is best to just look for other opportunities. The question is: What is your overall portfolio return and can you sleep at night?

  3. We never did really agree on how these things ought to be viewed I guess.

    If you have a chance, I suggest you read Options as a Strategic Investment by Lawrence McMillian. Despite the pompous title, it’s the best primer on how options work and to think in terms of the greeks that I know of.

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