Open Question Time!

Is it better to do covered call writing with stocks that are $20-$30, or those above $50???

Where the price range of the underlying stock really comes into play when we’re talking about covered call writing is in money management.

Remember, you have to own increments of 100 shares of the underlying stock to write a covered call.

If I am looking for covered call writing candidates where I am required to buy the underlying stock (versus already owning the stock for one reason or another), I generally look for underlying stocks that are $20 or less. That translates to needing a max of $2,000 chunks of initial investment.

I hope that makes sense.

Great question Mark.

What about using an in-the-money LEAP instead of the actual stock for creating covered call positions?

Hey M.P.,

Writing and option on an option. Even with an in-the-money LEAP, you are adding variables that you wouldn’t otherwise have with just owning the underlying stock.

So long as you know what you are doing, the strategy is viable. I like the strategy you brought up, but you need to do more due diligence, preparation, an monitoring of the trade.

As with anything, their is only risk when there is no knowledge. Have the knowledge and the risk goes away.

Hello,
Would like to learn more about covered calls and the various strategies.

What is the delta range you are looking for when writing a covered call?

Correct me if I’m wrong but I’m getting the impression that your apprentice program is for those traders who wish to make “trading” a full time career? Is it possible to do both: “trading” career and “professional” career??????????

R/
“Doc”

AJ,

Is there is a quick and easy way to find great trading opportunities?

Barry

If you sell a covered call, and the stock price starts to run way above your call strike prior to expiration, do you ever buy the call back, roll to the next month, sell a call at a higher strike and the sell a put to recoup some of the lost potential gain?

Hi Sergio,

I approach covered call writing differently.

Depending on the underlying stock, I will choose a strategy of either getting called out for a one-time deal. Or, not getting called out and instead just collecting premiums all along.

I therefore don’t measure delta when selecting the appropriate option to sell.

Hi Doc,

The apprentice program is focused on making your trading practice very efficient and as automated as possible.

I’m not sure where you got the impression that the apprentice program was for traders who want to trade full time.

The opposite is true.

In fact, if you’ve been around me for any amount of time, you would know I get an allergic reaction when someone says they want to trade full time.

For me, being a full time trader is not the dream lifestyle. Being a trader is the means to the end of a dream lifestyle.

Most of my past and present apprentices are professionals with full time careers (until their trading profits are larger than their career profits - even then, they don’t go to trading full time.)

Hope the record has been set straight.

Hi Barry,

The short answer to your question is yes.

Quick and easy comes with knowledge, experience and skill.

If you have no knowledge, experience or skill with trading, then no, it won’t be quick nor easy. And, it will be painful both in time and money wasted.

If it were quick and easy for those without knowledge, experience and skill, wouldn’t everyone be doing it?

I caution everyone… THERE IS NO HOLY GRAIL to trading. There is no blue pill you can take (a reference to the movie the Matrix).

I need to learn paper trading so I can practise Where do you suggestb I go and what do I read

Hi A.J. Thanks for the speedy reply and thanks for setting the record straight. This is exactly what I’m looking for. Sorry to bother you but I’m relatively new to the “team”.

R/
“Doc”

Hi Doc,

No worries. I’m sure a ton of others got clarification as well.

I find that when I have an impression of something, I’m usually not alone. So, if you had that impression of the Apprentice program, there’s a good probability that others did as well.

Phew. Glad we go that settled.

Hi Francis,

I think you’re asking how to paper trade. Go to your local office supply store and get a notebook. At the top of page one, give yourself some money. How about $5K, or $20K. Make it as close to the real amount you’ll be starting with when you’re ready.

Then, start trading that “virtual” money.

Record the Option, your buy price and the number of contracts you bought. When you sell, record your sell price and the number of contracts you sold. Calculate your win or loss and calculate your ROI. Record your comments for each trade.

That’s it, that’s all.

If you want to get more in depth, record commissions.

And, before graduating to real money, transition to a simulator instead - still virtual money but with a live online interface that is real time. Simulators are the closest to real trading without using money. The CBOE has a nice free simulator powered by options express.

For more on paper trading, check out one of my previous blog posts on the subject.

http://www.tradingtrainerblog.com/option-trading-with-zero-risk/

Hey Dennis,

Sorry I missed your comment.

What you describe works well so long as you can keep it all straight in your head.

As you play around in reaction to an underlying stocks change, the chance of a clerical error increases drastically.

Again, it comes down to knowledge, skill, and experience. If you have those, you’re good to go.

We love it when a good plan comes together.

could you explain the best way to close out adebit or credit spread at or near expiration??

Like you have a method of creating a call option buy, watch list using the IBD. Do you have a similar method for creating a put option buy list?

I’m interested in spread trades….what are the pros and cons of doing a debit spread and credit spread

To: A.J. Brown.

I have Lost my Password and Username. Please send my Username and Password to my E-mail Address. This is the way,that is private and protected to receive tha info.
Thank you very much.
David

my password And username please. I need them! please!

Do u trade vertical spreads and if so, which are your preferences - DEBIT spreads(i.e…Bull Call/Bear Put) or CREDIT spreads (i.e..Bull Put/Bear Call)and why?

If Covered Calls & Naked Puts are ’synthetically’ the same, why are covered calls considered very conservative strategy, whereas naked puts are viewed as very risky strategy?

with a stock like google that has so much volatility, i was wondering would it be a bad idea to open a call and a put simultaneously, being that the intra day swings are son far apart at times.

A.J,
When a company makes its way to the watch list (after passing the fundamentals test), do you check later after sometime to know if it still qualify? If yes, how frequent?

hi there Jim,

Listen, the situation you describe is one I would never get myself into. I stay away from near term options. The exponential time decay goes against my trading strategy.

Sorry to now want to answer your question. But, I’m all about the easiest way to make massive returns.

David,

I wish I could pull your user name and password out for you, but, I hope you understand, managing the administration of a member website is not my thing. I trade. And, I teach trading.

Why don’t you place a support ticket with our customer service team. They are there waiting to help you. That’s their purpose in life.

http://www.tradingtrainer2.com/contactus/

Thanks in advance for understanding. If you have a question about trading, like my article here is requesting, I’ll do my best to answer it. Cheers!

Hey Dan,

Great question. Although you can prove on paper that Covered Calls and Naked Puts are ’synthetically’ the same, in use and in application they are not.

Hi Michael,

When you play roulette, do you put money on both the red and the black? (I’ve actually done that… my strategy was to get the free drinks for being a gambler.)

Hi Mnouri,

Yes, you must check stocks on your watch list to see if they still qualify. But, not the way you are thinking.

We don’t use the same criteria to evaluate whether a stock still deserves to be on our watch list that we use to let it be on our watch list in the first place.

Remember, a stock we’re able to trade options on is accepted on our watch list because it passes the criterion professional traders use to pick strong stocks.

Periodically, we go through our watch list looking at stock charts to determine how my stocks, in the past months, were not able to be traded or, even worse, gave us false positives all too often on our standard entry and exit signals. Those get the boot.

Also, if the underlying stock price or the option’s open interest falls below our thresholds, we retire it.

Hope my response gives you that missing piece of insight you were looking for.

[...] off, if you submitted a question for me to answer, THANK YOU! This blog is about education, but it’s also a dialog. And the [...]

When buying an option, lets say a call, how do you determine the amount of time to buy?

Hi Kathleen,

There’s a lot of factors that go into deciding how far out you buy your option.

One rule I have for myself, is I for sure never let my options become near term (within a month of expiration). With the way I invest in options, not having to deal with the exponential time decay that happens when an option is near term is critical. (I use options as leverage on good looking underlying stocks.)

After making sure I do not go near term, the next thing I do is consult my money management rules (how much can I afford) as well as evaluate how long I plan to be in the position.

How long usually depends on what kind of setup I am looking at. A breakout for instance would be a trade I will not be in for a long time. A trend follower could be one I am in for months.

I also make sure the option(s) I’m interested in has plenty of open interest.

Finally, I like to setup a grid to bracket my option selection. I compare options against others that are one more step in the money, as well as, one more step further out. Sometimes the price to go out an additional month or two is really inexpensive. And sometimes the price to go deeper in the money (secure more intrinsic value) is really inexpensive.

There of course are ways to quantify all these steps, but that’s a whole long topic in itself. But, what I’ve written, is the general idea.

Hope that helps!

Hi AJ,

How long would you consider an average amount of time to be paper trading before “going live” (I have been paper trading for over a year and only now just starting to see results!)?

When we write a covered call we want the stock to be uptrending but consolidating or in rest mode, right? How long do we look for the stock to be in this rest mode before we consider it a candidate to write a covered call on?

thanks for your quick responses and the great insights

Hey Andrew,

Great question. Let’s see if my answer is just as good.

I don’t think it is actually a matter of time. After all, I paper traded for close to three years, and still do in parallel with my real money trading.

The answer is that you keep paper trading till you have built up enough confidence to trade real money.

Here are some suggestions, though. Before jumping from paper trading to real money trading, try simulator trading first. And, when you do go to real money trading, start small.

I’ve seen it over and over. In paper trading we start from a crawl, we stand up on two feet, we walk, and then we finally run. For some reason, though, when we switch to real money, in many cases, our run screeches to a halt as we fall to our knees and again have to start from a crawl.

Let’s transition slowly into trading real money so we don’t lose our momentum.

Thanks Andrew.

Hi TJ. With highly volatile stocks (e.g. Goog, Bidu, Fslr,etc…) are you ever a SELLER of calls & puts so you can take advantage of the overpriced premiums and have theta decay work in your favor. Or do u still BUY calls & puts - even if they are expensive given it’s high volatility?

TJ. Thanx for your response regarding spread trading…but for expensive stocks like CME, Goog, Bidu,etc…don’t you think it’s wiser (& more cost-effective) to use Debit or Credit Spreads so u can trade them at a much cheaper price?

I’ve just started trading ‘debit’ spreads & the few i’ve traded (e.g.Rimm, Aapl,Ma)it’s easier to ‘double’ your money with a smaller movement in the stock than with reg calls & puts. But the downside with spreads is - if the stock goes ‘ballistic’ (e.g..ISRG,MA,VMW after earnings), your profits are capped & u miss out - big time.

Hi A.J.:
When we buy an option and we want it to react as closely as possible like the underlying stock do we purchase at the money, 1 or 2 strikes in the money; and does the underlying stock need to be above a specific price?

Alright Theo… The first time I thought it was funny. Now I think you are doing it on purpose. Why do you keep calling me TJ? My name is A.J.

With regard to your question, the strategy I like the best is to find underlying stocks that are setting up for predictable movements and then leveraging that movement with an option that moves just about in lock step with the stock. To do that, I buy farther out in time and deeper in the money.

The Black Scholes approximation of option premium price is based on a best-fit polynomial equation. This, by the way, is where your theta is derived from. The only problem is that the market is based completely on human motion and sadly not mathematical model comes close to being accurate. Not even Black Scholes. (You can see this over and over if you use a Black Scholes pricer and compare the theoretical option price to the real option price.)

I prefer to not base my trading practice on an approximation of movement. I keep it simple. I find a good stock. I leverage its movement with an option that will move in lock step motion.

Thanks. Now… how can we work on getting my name right in the future?

Dan… Have you been hanging with Theo? My name is A.J. Where did this TJ come from?

With regard to your questions…

What trading style and respective strategies you choose are completely up to you. I can only tell you what has worked best for me.

The methods I use to pick underlying stocks finds the ballistic movers. I leverage their movements with options. I make a lot of money.

If spread trading works for you and you are happy with the results, then I celebrate and appreciate you. So long as you are out there doing it, you’re good as gold.

Hey Shawn,

Great question!

What I’m trying to do to leverage a stock’s movement with an option, is emphasize the intrinsic value component of the options premium price and deemphasize the time value component. The easiest way to do that of course is to buy deep in-the-money. However, that is not always the most cost effective way. You often don’t get the best bang for the dollar invested.

Another tactic is to try to stabilize the time value component as well as de-emphasize it. So, what are the variables that go into the time value? The big one’s are time before expiration and volatility.

The time before expiration really has a massive effect when an option becomes near term. To stabilize this variable, I don’t trade options that are near term.

Also, when evaluating an underlying stock, one of the criterion I look at closely is volatility. The less volatile the underlying stock, the more stable the time value component of the option premium price, the less I have to go deeper in-the-money to emphasize the intrinsic value over the time value.

This is a subject I’ve talked about for hours, so I hope my brief summary in this blog post comment does the topic justice.

As far as underlying stock price, I like more expensive, because stocks tend to move with their sectors and options tend to have a simillar starting price. In other words, you get a better bang for you buck with an option, the more expensive it is.

And, more expensive stocks swing bigger, meaning we can use our roll up strategy very effectively to really supercharge profits.

Thanks for asking these questions, Shawn. Good luck.

If I call you AJ will you answer my question? Just kidding. I’ll ask it again. When we write a covered call we want the stock to be uptrending but consolidating or in rest mode, right?
How long do we look for the stock to be in this rest mode before we consider it a candidate to write a covered call on?

Thanks for your opinion on spread trading.

What are your feelings on different time frames and trading styles? ie., shorter term capturing moves, longer term capturing trends.

Ken

In choosing the “easiest way to make massive returns”, have you examined the other markets?

If you have, is there a reason you chose stock options?

Do you have an opinion on the difference between options, futures, and forex?

what do you mean when you say “look for stocks that are setting up for predictable movement”?

Oh Kathleen…

I’m sorry I missed your question from February 6th. Yes, you get points for not calling me TJ. I still don’t get what that’s all about.

Your question deserves more than a comment response in a blog to actually do it justice. I have taught a good portion of a whole day on this subject alone in my Intensive trainings.

The long and the short of it is, it depends on what strategy you are using. At a 100,000 foot level, if you are looking to own the underlying stock a long time and just collect premiums every month, than you want a stock to be channeling horizontally. The longer the better. At least long enough that support and resistance of the channel has been challenged enough that they become solidly established. At least that’s my experience.

There’s more to it, but there’s not enough room in this blog to dig down deeper on the subject. And, as I read through my response, it is actually fairly thorough and complete. I hope you think so.

Don’t forget about defensive strategies should the stock price drop. Contingent selling of the underlying stock and then buying back the option when the premium is almost nil, is one of my favorites.

Thanks Kathleen for contributing to the blog. Good luck in your trading practice.

AJ,
When you sell calls, do you usually try to hold them for expiration, or do you trade them, in a similar manner to your short term stock trading. Of course without the need for a big move.

Also, how much time do you consider optimal for selling? Front month expire quicker and have greater time decay, but one or two months out have a higher premium and can profit well from a pullback.

As long as we are using options as a leveraged proxy for trading the stock, and not employing directionless and volitility based spread strategies, is there a good reason to trade options in preference to the other leveraged vehicles.

As long as we are managing our risk through the use of stops and our trading skills, and not relying on the price of the option to limit our risk, is there a solid reason to prefer options over Forex or futures?

same question as further above, just reworded a bit.

How has your overall strategy changed since this time last year?

Short term trades are still abundant and powerful, but the underlying trends are not as secure as they were.

thanks

I’ll try not to ask too many more questions

Ken

Thank you for answering my questions. my question was denied so i thought I would see if it was just that question or maybe you are done with this thread.
Kathleen

Hi A.J.

Thanks for this opportunity to let us obtain a little
piece of your great wisdom.

When in the process of analyzing particular stocks that may be included in a watch list, do you use the S&P 500 or DJIA to see areas of support and/or resistance?

In other words, would it make sense to you to buy and hold a call option on any financials that may be in a pullback if the S&P appears to be below a strong long term resistance?

Thanks in advance

Dario

Hi TJ…….ummm, MY BAD…i mean A.J. I don’t know where TJ came from. Anyway, AJ is burned into my consciousness for future reference.

OK, great response to my theta question. I’m feeling your ‘take’ on things. By going Deep ITM you have ‘less’ time value, hence less time decay to worry about, right? This is what i attempts to do by buying options with a delta over 75% so i can mimic the stock mvmnt as much as possible.

I really think this is a superior ‘long-term’ strategy than buying stock……i.e…just buy a longer term option with a high delta. No-brainer and save a boat load of money in the process.

But AJ, burning question here…. i’ve noticed that many professional traders are SELLERS of options not buyers. We all know that over 70% (probably 80%) of options expire wortthless. So that translates into the ’sellers’ making most of the profits, no? And when volatility is HIGH, does it NOT make more sense to SELL into the volatility instead of buying ‘overpriced’ options? Your take, plz.

Finally, AJ, i thinks i can speak for others as well as myself, we greatly appreciate you taking time out of your busy schedule to respond to our queries. I’m learning a lot from this.

Hi AJ. WOW!!! That was a great reply to Shawn’s question regarding Time & Volatility. Buying deep in the money & buying more time is a great way to mitigate time decay & volatility. Awesome!

But aren’t there times when you buy the ‘front’ month & out the money options…e.g….current news events like the problems CME was having with the justice dept that caused a 1 day drop of 103pts a couple days ago?. Man, i wish i bought some puts that day. How would u have played CME that day?

Also, what about earnings plays..esp. with expensive stocks that have ‘mega-moves’ post earnings…e.g..ISRG, MA, AAPL,etc….? Do u play earnings and if so, how would u have played stocks (like above)?

Thank U sir.

Hi Ken,

In one comment you asked me about my feelings on different time frames and trading styles.

Let me start with this underlying philosophy that I base my whole trading practices on first…

I have feelings, thoughts and opinions. So does every other person in the world. However, how does having or, even worse, sharing those opinions effect the “thump” value of your wallet? It doesn’t.

I just do what works, never mind my, or anyone else’s, feelings, thoughts and opinions.

Now, for a specific answer to your question. If you have the right (1) tools, (2) knowledge, and (3) experience, to trade a particular time frame and / or execute a particular trading style, proven through you consistently ending quarters with a bigger portfolio, then I like it.

Hi Kathleen,

I apologize for being vague when I said, “look for stocks that are setting up for predictable movements.” Let me hash it out a little better.

Think about a best friend… a friend you’ve known since just about the beginning of time. You know this friend so well, you’ve been around this friend for so long, that you’ve seen how certain situations make your friend react.

I can think of one of my friends and I know, when a certain topic of conversation comes up, that my friend will undergo a change in disposition. This happens every time without fail. In fact, my friend will even undergo physical change. Sweat will bead on my friends forehead. And, the corner of his mouth will start to spasm.

In my situation, I know, for instance, when my friend and I are at a cocktail party with people that were not familiar with, that if someone unknowingly brings up this topic, that it’s a smart thing for me to jump in and change the topic quickly, right. That’s because what’s setting up is a predictable movement.

Think of stocks as your friends. (That’s actually not that far a stretch because the price movement behavior of stock is driven completely by human emotions, yes or yes?) Instead of sweat on the forehead and a mouth that spasms, how about an oscillator indicator that goes opposite a trend followed by a confirmed reversal (both easily seen on a stock’s chart). Or, how about a buildup of price before a split, only to have a sell off right after.

Does that help?

Wow Ken… I am going to have to cut you off soon.

Ken, in the way I trade options, I do not let my options become near term, let alone go to expiration. The exponential time decay doesn’t do well with me trying to have an option that moves in lock step with the underlying stock.

With respect to how far out in time before expiration I buy, that depends on the underlying stock setup. In some cases I go 2-3 months out, like for short term trends and stocks that are channeling. Others 5-6, like long term trends.

Sorry, there is not one strategy that works in every situation.

Last one Ken…

The only component of my strategy that has changed since this time last year, is how I calculate my stop loss threshold on trend followers. In other words, my strategy has barely changed at all.

My overall strategy is broad enough that it works no matter what. I just look for different setups and trade the appropriate options that leverage that setup.

Hey Kathleen,

Your question was not denied. And, I’m not done with this thread. I just don’t get to answering blog comments as often as I would like.

I appreciate you for checking out my blog now and for a long time to come. It’s because of you, and people like you, that I do this.

Hey Dario,

Thanks for posting to my blog.

And, thanks for the comment about me having great wisdom. Would it be out of the question for you to share that with my close friends and family? As much as I tell them I have great wisdom to share, they often just laugh. :-0

I use the S&P500, DJIA and NASDAQ to establish my overall trading bias because these “big 3″ best represent my watch list. It’s very rare that, with my strategy, that I go against the trading bias. It’s like paddling a boat in while the tide is going out.

Hope that helps.

Hey Theo,

First off, just like I responded to Kathleen a couple above, I really wish I could answer blog comments more than my schedule allows right now. I do so love these interactions.

The option selection process really does vary on the underlying stock setup. If the stock is setting up for a very transient and high amplitude movement, like a breakout, I am generally going to go closer in time (never near term) and deep in the money. If the stock is setting up for a long duration and very controlled swing, I am generally going to go farther out in time and more at-the-money.

Yes, lately, the market has been giving us more transient motions… but, not on every underlying stock. There’s no blanket answer for one option selection strategy based on broad market conditions.

For me, I have a few hard and fast rules. Don’t hold an option near term. And, don’t buy out-of-the money options. From there it depends on the underlying stock setup.

And, I trade options. I don’t hold them till expiration.

Hi Dan,

I don’t chase news headlines. You can always look back and say man I wish this and man I wish that… but while you are wishing and mouth watering about what could have been, I’m trading predictable stock movements that reliably put money in my wallet every month.

I don’t go near term. I don’t go out-of-the-money. That’s just me.

[...] you participated in the open question time, thank you! I really enjoyed hearing your questions and having the opportunity to respond. Counting [...]