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Saturday, September 8, 2007

4 Steps for Establishing a Great Covered Calls Portfolio

Step 1. The Big Picture - It's important to have a personal outlook for the overall stock market. Are you bullish, bearish, or neutral for the near-term future of the market? This outlook must not be obtained quickly or emotionally. Rather, our outlook should result from: (1)avid reading of high-quality financial resources; and (2) from applying a disciplined ratings process that includes several macroeconomic, momentum, value, and growth factors. My current outlook will always be shown as the top information element in the right column of this blog --
For now, "The Covered Calls Advisor Says: The Current Overall Stock Market Outlook is : SLIGHTLY BULLISH. The Corresponding Investing Strategy is: SELL SLIGHTLY OUT-OF-THE-MONEY COVERED CALLS."
Generally speaking, covered call positions should be established that are consistent with your overall market perspective, namely:
Bullish -- Plan to sell primarily Out-of-the-Money(OTM) Calls
Neutral -- Plan to sell primarily At-the-Money(ATM) Calls
Bearish -- Plan to sell primarily In-the-Money(ITM) Calls

Step 2. Stock Selection - Stock Selection is Job #1 for the stock market investor, and it's also the most important decision for us covered call investors. Consequently, there will be a lot of information provided in future posts describing how this Advisor analyzes and selects stocks for inclusion in a covered call portfolio.

Step 3. Analyzing the Covered Call Investment - Once good stock investment candidates are identified, it is essential to perform additional analysis to determine which covered call option positions available will provide the best combination of both attractive return-on-investment potential as well as sufficient downside protection.

Step 4. Portfolio Diversification - Last, but certainly not least, is to ensure that the total portfolio of covered call positions is adequately diversified. The three components of diversification are: (1) Asset Allocation, (2) Sector Diversification, and (3) Individual Position Concentration.

There will be many future posts that will explore detailed aspects of each of these 4 steps with the intention of assisting you in refining and improving your own covered call investing decisions.


  1. I'm new to covered calls and am interested in a few strategy pointers:

    Do you invest all of your covered-call-portfolio money on the same day (if enough opportunities are available) or do you spread out your CC-Writing throughout the month?

    Do you tend to open positions within 21 days of expiration? 14 days? or as soon as the right opportunity (and free cash) presents itself?

    If the Call options expire and the shares are above your purchase price, do you move your money to a new underlying stock, or does this depend upon the Call options that are available at the time?

    Clearly you try to avoid this situation, but:
    If the Call options expire because the stock has decreased in value, do you sell the underlying shares for a loss, or write more contracts against the stock you are holding?

  2. Hi rnw,

    Excellent questions!

    When it comes to establishing new positions, my primary advice is 'Don't Hurry'!
    I normally write near-month covered calls, so all new positions are normally established for next month during the week immediately following the expiration Friday of each month.

    My current rules for when to sell an existing stock during the expiration period are:
    (1) I primarily use Schwab Equity Ratings and for stock selection. I'll sell a stock if its rating by either service drops from Buy to Hold or Sell; OR
    (2) Analysts' Consensus Future Earnings Estimates for the company have declined since I originally purchased the stock; OR
    (3) There will be a quarterly earnings release before the next option expiration date; OR
    (4) The annualized return if exercised (ARIE) on next month's nearest to at-the-money (ATM) option does not meet my minimum 25%+ threshold.

    This strategy results in a relatively high turnover in stocks each month. Normally, only about one-third of my stocks are kept for two expiration cycles. The rest are either called away (assigned) at expiration because they are in-the-money(ITM) or are sold because they faily one or more of the rules listed above. This strategy is one I'm comfortable with and you will likely develop your own strategy that may differ from mine but will nevertheless be right for you.

    Hope these comments are helpful. Please feel free to post another comment if you'd like further information on anything.

    Regards and Good Profits,


  3. Thank you for the pointers.

    One last question:

    Do you know of any low-commssion brokerage houses?

    I am paying $9.99 to buy, $9.99 to write and & $0.75 per contract (and another $9.99 to sell if unassigned).

    This seems like a high commission rate, especially for the $3k through $7k contracts I wrote up this month. (I was trying to keep my portfolio diversified, but maybe I over did it.)

    Thanks again & count me as a reader of your blog.

  4. Your current commissions are not unreasonably high. In fact, they are very close to what I am paying at Charles Schwab.

    However, here is a quote from a March '07 post from Mike Artobello (who is the Moderator of the site) in which he says: "IMHO, IB is the best place to trade covered calls, especially if you put on small positions (i.e. less than 10 contracts). A 1 contract CC position only costs $2 commission and there's no commision charge for assignment. Can't beat that anywhere."

    Note: IB stands for Interactive Brokers. Also, Mike A. is a very astute covered call investor, so since he uses and recommends IB, then you should feel confident in choosing them.

  5. Hi Guys,
    As far as the Brokerage account goes I use both IB and Fidelity accounts.
    1. IB is very cheap. No mins and they charge like .75/contact. But I find their record keeping and reporting to be very cumbersome. It confuses me little and there is no way to look up you order history just the report of holdings at the end of the day/month/year,etc.

    2. Fidelity is little pricier almost same as your rates. $10.95 min plus .75 per contract. But if you do a "Buy Write" then the stock is charged at $10.95 and then the options are charged at $.75/contract with no minimums. So you save one leg of the commission. Howver you will pay stock trade when you get called away.

    I am a newbie to CCs as well trying few strategies to see which suits my taste and tolerance the best (well, market is not helping me). Also, is there a place you guys post your analysis before you buy a stock so we can compare each other's choices and buy maybe at the same time so we can compare each others choices,etc. I am finding it so hard to find 5 or 10 stocks worth trading for cc in this market, takes too much time.

    I currently have NTRI and CRNT in my cc portfolio. They are doing ok.

    Happy profiting