Covered Call Strategy... makes sense?

{snip]

Shhhh,

I'll take a shot at it. Assuming you did the math and understand it, there are a couple of points:

1) He's using rounded numbers - you need a bit more that $10,000, first to cover the rounding up he used, and second to cover the commissions. There's also the little matter that to actually implement that, (I've never tried it) you'd have to find a broker who would do it, since basically you are 'moving through' an 11-to-1 margin position. My guess is you would have to have some $60,000 in purchasing power to margin the purchase of 3700 shares, then the same day sell the calls for $27.50 each to replace the cash (less the $10,000). 2) I think the main points to look at aside from the math are that whoever bought the calls has a fairly strong economic incentive to exercise them in order to collect the dividends. Since options are randomly assigned, you're assuming that the buyers are sufficiently asleep as to not notice the dividends, or they figure the dividend will be cut or eliminated, or some other reason (possibly tax-related) I haven't thought of, or some spread strategy the buyer implemented that involves closing out the calls against an offsetting position. Out of the money calls, there's no incentive to exercise. Slightly in the money calls, you might get an exercise. With deep in the money calls, your chances of exercise increase, especially if the dividend is attractive. 3) I didn't check to see if the options pricing offered is correct or not. Usually, you don't see calls that deep in the money - for some of the logic given above (why not buy the stock and collect the dividend?). The only ones I've seen that far away from the current price were with a stock that had quintupled in the last 12 - 16 months. 4) If the stock dropped below $2.50 (say $2), you would be holding the shares - unlikely, but by that time there would probably be no dividend, and $2 x 3700 = $7,200, so you just eat the 30% loss on your $10,000, commissions, etc..

In summary, I don't really think you would collect the first dividend payment, and would simply lose the $777 (plus commissions). But there's a lot I don't know. I'd trust your intuition about it.

(I think I got the thing right, above. I stick with simple stuff, like buying 100 shares of XYZ at $30, then if it gets to $40, maybe selling the $45 calls - provided I'm indifferent if it goes to $50 and gets called away.)

-------------------------------------- Misc.invest.financial-plan is a moderated newsgroup where Moderators strive to keep the conversations on-topic for financial planning. Other posting guidelines include a request for brevity and another for trimming posts to which we respond. For all of the other tips and suggestions, see "FROM THE MODERATORS: Posting to misc.invest.financial-plan", a weekly post now on the Newsgroup.

This is the old Wade Cook strategy #1. This is one of those deals that works great on paper, but fails in the real world. The reasons are that the example doesn't include commissions, nor does it account for typical volatility. The problem is that the stock prices vary widely enough any given week that the market is likely to go up or down far enough that you will get called out, and the commissions to get your stock back will cancel out anything you make on the option. Even Wade Cook lost his pants doing this stuff, so be careful.

-john-

When an option is that deep in the money, it's often called away. i.e. you find yourself with cash instead of the shares. And it often happens just before the dividend is declared. I suggest you look at the options tables and study the activity of a few (dividend paying) stock's strikes which are deep in the money. I had the same idea with MO some time back. I watched the open interest drop like a rock the day before the stock went ex-div. Meaning the options holders exercised their right to buy the stock, and pay you the remaining $5 or whatever to own the stock and not the option.

Joe

-------------------------------------- Misc.invest.financial-plan is a moderated newsgroup where Moderators strive to keep the conversations on-topic for financial planning. Other posting guidelines include a request for brevity and another for trimming posts to which we respond. For all of the other tips and suggestions, see "FROM THE MODERATORS: Posting to misc.invest.financial-plan", a weekly post now on the Newsgroup.