Covered Calls for Fun & Income

Trading Plan

This is my personal trading plan for Covered Calls. When I sit down in front of my PC in the morning, I read this from beginning to end. Feel free to use this and modify for your own purpose.

You can download a Word copy using the link at the lower right and it’s much easier to read.

Strategy

Covered Calls – Outlook: Neutral to Bullish

Objective is to find Covered Calls that will have the best probability of expiring In The Money (ITM) at the next expiration date.

Daily Methodology

Pre-Market Open

1)       Review previous day close charts on open positions and watch list.

2)       Note action, if any, for open positions and watch list.

3)       Check news on open positions and watch list.

4)       Log into Interactive Brokers trading account.

5)       Log into CallWriter and review open trades in Trade Management Calculator (TMC).

Market Open

1)       When the CallWriter lists begin updating, surf lists for prospects.

a)       Check CallWriter Lists for:

i)         Stock/Industry: favorable or not

ii)       Return Flat & Called: look for high return in a bull market and fair return in a bear market. Usually don’t go any lower than half way down the list.

iii)      Volume: prefer grater than 1,000,000

iv)      Open Interest: prefer greater than 500

v)       MADI: prefer two bricks or less in either direction

vi)      Note potential prospects

b)       When a potential prospect is identified, check the following on the CallWriter Research Page:

i)         Tech. D-Chart: Review chart price relationship to 20/50/200 SMA, MACD,  and Relative Strength

ii)       Tech. Signal: Check Overall Quality and Trade Summary

iii)      Fund. Fundamentals: Check Morningstar Stock Grade, PE relative to Industry and S&P, and Balance Sheet for Cash.

iv)      Earn. Earnings: Check for next earnings date and other earnings report data.

v)       H. Volatility: Compare 10, 20 & 30 day Historic Volatility against Implied Volatility of desired Call Option.

2)       Monitor broker account on open trades

3)       Monitor open trades in Trade Management Calculator.

4)       Open trades as defined in Entry Methodology

5)       If all open positions are stable and no prospects have been identified by 11:00 AM, go play golf.

Entry Methodology

1) Trade the Trend —– Trade the Trend —- Trade the Trend

2)       Technical – Daily Chart: Review chart price relationship to 20/50/200 EMA and other indicators:

a)       Price should be at or near 20MA

b)       Price should be in a uptrend or range-bound

c)       Stochastic preferably rising from or crossing 20 mark

d)       Relative strength in an uptrend

3)       Technical – Signal: Check Overall Quality and Trade Summary (NASDAQ Stock Consultant)

a)       Overall Quality should be more Bullish than Bearish

b)       Trade Summary should be more Upside than Downside – the greater the better

4)       Fundamentals: Check Morningstar Stock Grade, PE relative to Industry and S&P, and Balance Sheet for Cash.

a)       Stock Grade of C average or better in all categories

b)       PE is a gut thing, but generally if the stock PE is lower than the industry and all other factors look good, the stock could be oversold

c)       A large amount of cash relative to capitalization is a good sign

5)       Earnings: Check for next earnings date and other earnings report data.

a)       Avoid expiration dates that are later than the next earnings date – not a ‘cast in iron’ rule, but it could hurt. If the stock is in a solid uptrend, you could enter and plan to exit for a profit prior to earnings.

b)       Check previous and forecasted earnings for increases.

6)       H. Volatility: Compare 10 day Historic Volatility to Implied Volatility of the Call.

a)       Avoid consideration for a Covered Call if the Implied Volatility (IV) of the desired Call strike and expiration is higher than the 10 day Historic Volatility (HV).

b)       IV should be less than 10 day HV.

7)       The expiration date should be no further the current month (or next expiration date).

8)       Decide if entering as a Buy-Write or Legging in

a)       If the stock is in a strong uptrend, consider legging in: buy the stock and wait for a price rise before selling the call to increase premium – do not wait longer than 3 days

b)       If the stock is consolidating, then enter with a Buy-Write order

c)       Always use LIMIT and DAY only orders

d)       Record trade into Trade Management Calculator, and spread sheet

Managing and Exiting Trades

Monitor all open trades daily.

The following is a guideline for managing open Covered Calls (for scenarios not covered here or additional detail, reference the Ultimate Covered Call Book. Chapter 10)

1)       The underlying is gaining in price and has passed the strike price of your short Call and expiration is several days away.

a)       If closing the trade early results in a gain of 80% of better of the original ITM gain, consider exiting and re-investing the capital in another Covered Call for the same month.

b)       If expiration is not far enough away to justify another Covered Call, let the trade ride.

2)       The underlying is falling in price and has passed your Cost Basis and expiration is several days away.

a)       Always consider time value premium as a means to lower Cost Basis when evaluating decisions in this situation

i)         If the stock looks like it is in a huge selloff, close the trade immediately.

ii)       If the stock looks like it is in a normal pullback, consider rolling out or out & down, but always attempt to do it for a profit.

iii)      If the stock is in a consolidation pattern, let it expire OTM and re-evaluate the following week.

3)       Covered Call has expired OTM but near the original strike price.

a)       Wait 2-3 days after expiration and observe stock price action.

i)         If it turns bullish, sell the stock at or above the expired Call strike price.

ii)       If it is in consolidation evaluate writing a call for the next month – but only if there is a decent return.

iii)      If none of the above are true, sell the stock, take the loss and move on.

4)       Covered Call has expired OTM and well below the original strike price but above or at Cost Basis.

a)       Wait 2-3 days after expiration and observe stock price action.

i)         If the price action is bullish, sell the stock on the 4th day.

ii)       If the price action is neutral or bearish, sell the stock immediately.

Trading & Money Management

1)       I will NOT chase a trade

2)       Before entering a trade, I will document at least 4 reasons for entering the trade

3)       On entry I ALWAYS use Limits

4)       I will always attempt to write Calls above my current Cost Basis, understanding that there are times when this is not possible without taking a heavy loss

5)       I actively manage open positions for violation of pre-defined exit points

6)       The most I can risk on a single trade is 10% of the account total

7)       Always leave 10% or account balance in cash

8)       I will stop trading after 2 losers in a row and will review those trades before continuing.

Psychology

Psychology is 90% of trading. If I don’t know myself – I can’t trade effectively.

1)       I will always have at least 4 written reasons to trade. This is so I can refer back to my reasons and dispel any doubts or fear.

2)       I will not trade ‘for the heck of it’. My written plan will help to remind me if I am making mistakes.

3)       I will always respect the market, knowing that it will take price where it wants to go. I can only put my money in the likely direction and control my risk.

4)       If I have several losses in a row, I will focus on the pattern – not on getting revenge of ‘making it back’ – by focusing on the probabilities. That way I will know the losses won’t affect me over the long run.

5)       Do not allow a ‘Shoulda Woulda Coulda’ mindset.

I am a consistent Winner Because:

5)       I objectively identify my edges

6)       I pre-define the risk of every trade

7)       I completely accept the risk or I am willing to let go of the trade

8)       I act on my edges without reservation or hesitation

9)       I pay myself as the market makes money available to me

10)   I continually monitor my susceptibility for making errors

11)   I believe trading is a game, and there are winners and losers

12)   I believe trading is like a casino which does not win all the time but wins a majority of the time

13)   I am a successful trader

14)   I can accept loses without guilt

15)   I can accept winners without guilt

16)   I believe my profits are mine to keep and do not give them back to the market

17)   I have no guilt about keeping my profits

18)   I deserve my profits

19)   I faithfully follow my trading plan

20)   I am patient and plan my entries and exits in advance for trades

21)   I can recognize what the market is telling me and will exit/reverse a trade if necessary

22)   I am open to all the market is telling me and will not panic when a trade is losing

23)   I am patient and actively manage my open trades

24)   I am open to learning new techniques and methodologies

25)   I spend time each day to learn something new about trading

26)   I understand the absolute necessity of these principles of consistent success and, therefore, I NEVER violate them

7 Comments »

  1. Excellent Trade Plan! Thanks!

    Comment by John Hamilton — April 12, 2009 @ 12:10 PM

    • Thanks John. It’s your to use in any way you wish.

      Comment by Jeff — April 12, 2009 @ 12:56 PM

  2. Excellent plan. Reading your blogs are helpful. Thaks for sharing your success and challenges.

    Comment by Mike — April 20, 2009 @ 6:13 AM

    • Thanks Mike.
      I am really enjoying this blog. I never thought it would be this much fun. I appreciate your comment and challenge other readers to comment or start a discussion. There must be something I wrote that others have something to say about, right?
      Jeff

      Comment by Jeff — April 20, 2009 @ 6:28 AM

  3. Like your blog and plan but don’t see alot of info on the “downside” of covered call writting. I mean the market we’re currently in who knows the direction it will take? One day we’re up +100 then the next we’re down -100….seems covered call writting is only a bullish trade…What do you think of “covered stock” writting?

    Comment by vaughn — May 20, 2009 @ 7:47 AM

    • oops…I stand corrected I just read your “superput strategy”
      would still like your input on “covered stocks”

      Comment by vaughn — May 20, 2009 @ 7:53 AM

  4. Vaughn,
    My understanding is a Covered Stock is buying Put near-the-money along with the stock – sometimes referred to as a protective Put.
    I do not have anything negative to say about this strategy, but I personally don’t use it – I prefer to be the seller of an option rather than a buyer, at least for right now.
    I may buy a Put to cover my stock but only as an entry method for a SuperPut.
    I have been tempted to buy Puts to cover open positions that have moved against me, but almost all the time I prefer to just exit and take my loss.

    Jeff

    Comment by Jeff — May 20, 2009 @ 4:23 PM


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