Covered Calls
Unfortunately, all good things must come to an end. My autotrader is still doing great, but it appears that it’s pushing up on the limits of how much capital it can trade before I move the market too much and slippage starts hurting it. Without any changes, the return on capital will start to slowly dwindle as the capital goes up, but the return levels off. So I need to find some new investment ideas.
I remember the first time I read about covered calls, aka a buy-write, I thought it was the stupidest strategy. Capped upside and unlimited downside don’t seem like a good combination. Then I learned a little more about position sizing and how to set a constant risk amount so that you don’t just view risk as how much capital you put up to establish the position. That made the unlimited downside part a little more manageable.
Recently I’ve been reading more about real estate (related to the fact that I need new investment ideas) and getting a much better grip on controlling cash flow. With a far better grip of expectancy analysis over when I first learned about covered calls, they’re actually starting to seem interesting to me when viewed as cash flow. After rereading chapter 2 in the McMillan options book as a refresher, I think I may start to dabble in this a little. I don’t know if I’ll actually follow through on this, but it may add some different types of stocks that I look at in the future.
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How are covered calls better than vertical spreads? It seems like the spreads require a lot less capital, so you could aim for smaller gains across more positions and make consistent money too.
A vertical spread (at least a bull call spread) is essentialy the same thing as a covered call, except you’re using a call option instead of the underlying stock. That makes it so that you’re also paying a time premium, so you’re betting much more on the movement of the stock and not just trying to profit off of selling the option. This means a bull call spread is a bet on upwards movement, whereas the covered call is more of a bet on a flat stock (but will still make some money if the stock moves up).