Saturday, April 25, 2009

The Covered Calls Monthly Cycle

There is a readily identifiable monthly cycle in the covered calls investing process, and this article will describe aspects of the cycle as it applies to the Covered Calls Advisor's approach. Hopefully, it will encourage you to analyze and to further refine your own covered calls investing style and process.

The primary factor that drives the monthly cycle is, of course, the fact that stock options have monthly expiration dates which occur on the third Friday of each calendar month. In addition, for the Covered Calls Advisor Portfolio (CCAP), this monthly cycle has an even more pronounced effect since this advisor's preference is to establish only near-month covered calls positions. For example, the CCAP now contains 15 covered call positions and all of them are for the near-month expiration, which is May 2009. If you are interested in pursuing this topic further, this advisor's rationale for investing exclusively in near-month covered calls was presented in a prior post on this blog:

We have just completed the first week of the May09 expiration month. When considering what typically occurs during an expiration month cycle, it is instructive to consider each week within the month and the primary activities during that week.
For ease of reference going forward, this article will address the weeks within any expiration month as follows:

(a) Week 1: The first trading week (Monday through Friday) after the end of the prior expiration month. For example, I am writing this article on April 25th during the weekend immediately following the completion of 'week 1' of the May09 expiration month.
(b) Mid-Month Weeks: There are either two or three 'mid-month weeks' since every expiration month contains either 4 or 5 trading weeks. In a 4-week month, the mid-month weeks are weeks 2 and 3; In a 5-week month they will be weeks 2 through 4.
(c) Expiration Week: The final trading week that concludes with expiration Friday each month. For example, in the current expiration month scenario of May09, 'expiration week' will occur between Monday, May 11th and Friday May 15th.

Now, let's consider the primary activities that occur during each of these three monthly time periods (i.e. week 1, mid-month, and expiration week) in the context of the current expiration month, which is May09.

Week 1:
As I write this article, we are at the end of week 1 for May09. This week's activities were primarily devoted to establishing new covered calls positions using the cash available at the end of the Apr09 expiration, which occurred one week earlier on Friday (April 17th). These new positions were established during this past week at a rate of approximately one or two per day for each day from Monday through Friday. There is no rush to reinvest all available cash on the Monday following expiration. But on the other hand, there is normally no need to delay establishing new positions beyond week 1; in fact, doing so begins to adversely affect the advantages of capturing the most time-value available from the call options being sold. For the Covered Calls Advisor, using all of week 1 to establish new positions is the happy medium -- a deliberate, disciplined pace that allows for a calm, rational decision-making process. This pace is neither too frenetic nor too prolonged. For this Advisor, it is just right.

Mid-Month Weeks:
There are four weeks for May09, so this month there are two mid-month weeks which will run from this Monday, April 27th through Friday, May 8th. During this period, position management is paramount. Existing positions are monitored to identify any that should be rolled-up or rolled-down to a different strike price. During the two mid-month weeks, any rolls transacted will be done with the current expiration month (now May09). A more detailed explanation of the specific criteria used by the Covered Calls Advisor for decision-making related to rolling covered calls positions will be the topic of a separate post on this blog in the near future.

Expiration Week:
Expiration Week for May09 will start Monday, May 11th and conclude Friday, May 15th. During expiration week, the primary activities include:

1. Deciding whether to keep or sell the existing positions. That is, which stocks do we want to retain for next month's covered calls and which stocks do we prefer to sell? This topic was addressed in a prior post:
Expiration week is the time frame when the Covered Calls Advisor takes action to keep those underlying stocks that will be retained to establish June09 positions and to sell those underlying stocks we want to eliminate from next-month's portfolio.
(a) For the 'keepers', if the stock is below the current strike price, we simply allow the May09 options to expire and thereby retain the underlying stock which can be established as a June09 covered call position early the following week. If the stock is priced above the current strike price, one of two alternatives will be implemented. Either a roll-out to June09 transaction will be done (by buying-to-close the current option and simultaneously selling-to-open a June09 option); or the stock will be allowed to be called away on expiration Friday on May 15th. At that pooint, the stock in the same company would be re-purchased on the following Monday, May 18th as the foundation for establishing a new covered calls position for the June09 expiration. To retain an in-the-money stock for the following month, either of these two approaches is satisfactory.
(b) For the stocks we wish to sell:
- If the stock is out-of-the-money, we will allow the May09 option to expire worthless on expiration Friday and then sell the stock soon after the market opens on the following Monday morning.
- If the stock is in-the-money, we will allow it to be called away on expiration Friday, May 15th.

2. The second primary activity during expiration week is stock selection. Although stock research can and should occur throughout the month, expiration week is the primary time to analyze and decide what new stock positions will be established for next month's covered calls. This activity is the single most important task for covered calls investors -- good stock selection is essential to achieving success with covered calls investing. The preferred stock selection methods used by this advisor are described in a prior post:

Hopefully, these comments have provided some food-for-thought as related to your own investing process. As always, your comments and questions are welcomed. Please provide them by either clicking the 'comments' link below or by posting them at the justcoveredcalls Yahoo!Group site. If you prefer confidential communications, my email address is listed at the top-right sidebar of this blog site.

Godspeed to All,


1 comment:

  1. I am a relatively new subscriber to CCA. I got here after formulating a covered calls strategy based on a book I bought.
    What's interesting is that the CCA approach follows the book, but expands on it in ways that the book left readers to figure out for themselves.
    The latest "Monthly Cycle" material is a fine analysis of the thought process required for optimum investment performance in in this area.