Minyan Mailbag - Covered Calls
Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.
Hello Professor Succo, I hope all is well.
I have reread your primer on covered call writing that you published awhile back, it is truly a wonderful resource. I have a quick question regarding proper strategy for covered call writing.
You discussed the mistake of "rolling down", and to not overtrade volatility should the price of the underlying drop by covering the short call of the higher strike and writing a new call at a lower strike. Agreed.
My question is: Does this 'rule' apply when a stock is purchased and a call is written immediately and let's say after 6 months the stock has declined and the option expires worthless, should I refrain from writing until the stock appreciates or is it prudent to write a medium correlation call at the current price (a .5 delta call will have a lower strike than my equity purchase price) and manage it by not letting it get too far in-the-money (.8 delta) if the stock appreciates?
I've got two voices in my head voicing their opinion on this strategy and I want to make sure the greedy voice doesn't get the upper hand.
Minyan George from Malta
There are two voices because there is no hard answer. My rules are more like guidelines: they are there to make you think more than anything else. They will help you avoid big mistakes.
The criteria in all of this, whether you are over-writing an existing position or entering into a buy-write, is that you have to feel comfortable owning the stock; in other words, comfortable owning it outright at a price less the option price. If yes, don't roll down. If no, you probably should be out of the whole trade.
Being short calls against long stock is only a quasi-hedge.
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