Fri 19 Jan 2007
Writing an ETF Covered Call – Epilogue
Posted by RichSlick under MMO, Money Trades
[2] Comments
If you missed my first post, you’ll want to read it here. Today is Options Expiry and it looks like SMH will close below the $35 strike price which means I get to keep the $850 (2.5%) premium AND I get to hold on to my shares so that I can write February 07 or May 07 Calls.
But what I really want to illustrate is how much mutual funds suck. Click on the graph to follow along.
If I had bought SMPSX (Semiconductors Mutual Fund) back in December 2006 at $17.34 I would be down 6% today. I know what some of you are going to say…..”Great time to dollar cost average down….blah…blah…blah”
Perhaps it is a great time to dollar cost average down and perhaps you’ll eventually make up the loss but while you’re busy dollar cost averaging down I’ve made $850 in cash that’s sitting in my account and I STILL own the shares of SMH just like you STILL own the shares of SMPSX. Look at the chart, the graphs lines are nearly identical except one of them generates cash flow (SMH) while the other just sits there waiting for something to happen (SMPSX).
Where do I go from here? I’m bullish on the semiconductor industry so I’ll hold for now. I have many options from here:
- Sell (currently $0.28 = 1% additional return)
- Sell (currently $1.25 = 3.6% additional return)
- Sell (currently $2.15 = 6.2% additional return)
- I can wait until SMH breaches $35 then sell May or August Calls which would yield higher returns.
- I can liquidate now and break even
- I can straddle or do some fairly exotic things
What can a mutual fund holder do?
- Buy more (to dollar cost average)
- Sell Fund and move to greener pastures (at a loss)
While I’m selling and making money you’re waiting and buying (spending money). Remember: YOU MAKE MONEY SELLING STOCKS NOT BUYING THEM.
Is it sinking in yet?
If it is, go over to to check out how I’m putting it all together.
Please note that the trading day still has a few hours left as I write this and SMH could rocket up to the moon in which case I’ll be forced to sell at $35 and only capture 4.6% return in 42 days but I’d be ok with that scenario too 
January 19th, 2007 at 7:25 pm
Slick:
First, I must thank you for your blog. I find it interesting and informative. Second, I must say that I am a total rookie at this thing so my below questions may be very dumb.
I have 2 questions regarding your covered call writing. First, I am looking for a little explanation regarding the ROI and the MAXROI in the report on etfcoveredcall.com. Specifically, I do not understand the ROI when you sell an in the money call. For example, on todays report, there is a ROI for a Feb. call for PBW of just over 8%. I am not sure how one can ever get this high of a return by selling this in the money call. Yes, you are getting the premium but you are selling for less than you bought for (assuming you get called out). So it seems that the ROI is inflated in the case of selling an in the money call such that one can never get such a return.
My second question is what you do when you sell a covered call and then the stock goes down more than the premium collected for the covered call. Seems like you have a net loss. Not a huge deal (for the time being), but if the stock has gone down much more than the premium, your options for selling additional covered calls in the next months might be limited (because I would think that you do not want to sell a covered call for a strike price lower than your purchase price). Do you have a strategy for such a situation?
Thanks again for your blog.
January 19th, 2007 at 8:17 pm
Good questions Rookie. I’m here to try to educate since you won’t ever learn about this from CNBC monkeys or from the bald guy yelling at you all day long telling you to buy or sell some stock.
The headers are defined on the ETF-Cashinator report link here
But to make it quick, ROI is the return you’ll make on your investment. It is a simple calculation of premium/investment.
In the case of PBW, the report is assuming that you buy at $16.83 and the ETF drops BELOW $16 and you don’t get called. On the other hand, if you buy at $16.83 and you do get called, you’ll only make 3.09% – this is MAXROI because you won’t own the equity after you’re called.
So let’s do the math. Let’s say you buy 1000 shares at $16.83 and you sell the $16 March 07 calls for $1.35.
Cost: 1000 x $16.83 = $16,830.00
Premium: $1.35 x 10 x 100 = $1,350
ROI = $1,350.00 / $16,830 = 8.24%
Now on March 16, 2007 two things can happen:
1. PBW will be ABOVE $16
In this case, you’ll be forced to sell at $16.00. You sell at $16.00 but you bought at 16.83. So $16.00 – $16.83 = -$0.83
-$0.83 x 1000 = -$830.00 (you lose $830)
but you made $1350 originally and now you’ve lost $830 so your net profit is $520.
MAXROI = $520 / $16,830 = 3.09%
2. PBW will be BELOW $16.00.
In this case you won’t get called and you will still own the 1000 PBW shares. Your net profit ROI = $1350/$16,830 = 8.24%
You asked what would happen if PBW falls way down perhaps to $11.20. Well it would be hard to sell $16 options 30 to 60 days in advance if it’s currently trading at $11.
This is where research and due diligence pay off. PBW is a clean energy ETF. Are you bullish on clean energy? Do you feel oil will climb back up and make clean energy competitive? Do you follow the energy industry?
I wish it could be as simple as looking at the report, picking the highest yield and click buy/write but there’s always more to it.
My personal goal is to hope to be called every time within the shortest time period and the two green highlighted items (yellow highlighted blocks) are ETFs that I hope will do that for me.
I have had situation where I bought a stock at $20 only to see it drop to $12 and I’ve had to wait it out for months. There is a real life example on my blog. Search for EXPEDIA to see the whole fiasco.
So to answer your question: my strategy for something that falls off the cliff is to hold if I feel it will recover or cut my losses and liquidate. Keep in mind, however, that I mostly trade ETFs with high volume and other parameters. Click here to see http://www.getrichslick.com/2006/11/03/my-etf-picking-methodology/
So I do try to do my best to ensure I don’t fall off a cliff but there are NEVER any guarantees.
I hope this helps & welcome.