Sunday, February 5, 2012

Best Book on Covered Calls

Three years ago, this Covered Calls Advisor blog wrote an article (See "Four for Your Bookshelf") that recommended 4 books that deserve a permanent place on any investor's bookshelf. One of those books was "New Insights on Covered Call Writing" by Lehman & McMillan, a book that the Covered Calls Advisor believed was the single best book available at that time dedicated primarily to covered calls investing.
Fortunately, the authors have now released a 2nd Edition of this book titled "Options for Volatile Markets". This book is a significant improvement over the first edition and should definitely be obtained and read carefully by anyone with an interest in covered calls.

The Covered Calls Advisor has read the book twice and also written a book review (published at, which for your convenience is duplicated here:

4.0 out of 5 stars Much to Praise -- But Also a Major Flaw, January 11, 2012
By Jeff Partlow (Annandale, VA United States)

This review is from: Options for Volatile Markets: Managing Volatility and Protecting Against Catastrophic Risk (Bloomberg Financial) (Hardcover)

PRAISE: First and foremost, I confidently assert that this book is the single best resource now available that is focused primarily on the subject of covered calls investing. To those who have read the 1st Edition of this book (titled "New Insights on Covered Call Writing"), this 2nd Edition is a substantial improvement. It is written with great clarity throughout and is worthwhile reading for anyone (from novice to expert) interested in covered calls and other closely-related hedging strategies. Some of the best features are:
1. Excellent definitions and explanations of options terminology; and especially insightful discussions of important topics such as time value decay, skews, implied volatility, and historic volatility.
2. A very good explanation of why a fear common to many newbie covered calls investors, namely early exercise, is largely unwarranted.
3. Thorough discussions related to position management (the authors call this "follow-up actions"), including various types of "rolling".
4. The section on "Basic Tax Rules for Options" is the best concise description I've seen anywhere on this topic.
5. Why it is critically important that investors develop knowledge of how "risk" and "volatility" should inform our investment decision-making process. Consideration of specific "traps" to be avoided is another especially strong feature of this book.
6. For investors interested in modifications to the basic covered calls strategy, hedging with protective puts, collars, and option spreads are also presented. Thankfully, the authors present these alternatives in a well-balanced manner, taking time to present both the pros and cons of each strategy.

1. I share the concern of some other reviewers that the revised title of this 2nd Edition is overly generic and therefore somewhat misleading. A more appropriate title would be something like "Covered Calls and Related Hedging Strategies".
2. Figure 6.4 is a very nice, visual way to portray the "Behavioral Impact of Covered Call Writing". But the stock price ranges are incorrect: "Good decision offset..." should be <$47, etc., etc.
3. Weekly options now exist for over 100 equities/ETFs and they continue to grow in both availability and popularity. Including commentary on the possible role of weeklies in the several instances when expiration timeframes are addressed throughout the book would definitely enhance the readers' overall understanding.

MAJOR FLAW: On pages 162-164, the authors present results from their own study of four strategies during 2007-2010. The results are summarized in Table 8.3. Unfortunately, there are errors in the "Total Period" column which will cause naïve readers to falsely conclude that the collar strategy provides substantially better returns than the other three strategies. Two of these errors are:
1. The actual overall performance of SPY over these 3 3/4 years was -13.1%, not -17.3%.
2. The +15.2% return claimed for the collar strategy defies basic common sense when compared with the returns presented for its related component parts, that is a covered calls return of +3.1% in combination with a put hedge return of -5.2%. We can also conclude that the +15.2% is also clearly inaccurate from a different viewpoint, since a time-weighted average of the flat period (+5.8%), down period(+0.4%), and up period (+16.7%) is much closer to +8.4% -- but definitely not +15.2%.
This major flaw should be corrected prior to the next printing of this book. Further, to improve the validity of the results, the current 3 3/4 years backtest should be extended to a more rigorous minimum of 20 years.

Note: The overall rating of 4 Stars will be upgraded to 5 Stars if the authors correct the indicated problems in a subsequent printing of this book.