Professional traders use the term "lean" to refer to one's
perception about the directional strength of the stock.
When you own a stock and intend to hold it for a period of
time, you are aware that you will probably be holding it
while it goes up and while it goes down.
This means that at any given moment in time, you might have
a different opinion of the potential movement of that
stock. Knowing this, there is a way to address your present
level of confidence or "lean." You do this by your choice
of which option you sell.
While it is true that the at-the-money option has the most
amount of extrinsic value, it might not always be the ideal
option to sell in every situation.
For instance, if you feel that the stock itself has a very
high chance of producing capital appreciation above the
potential amount of premium you could receive from selling
an at-the-money call, then sell an out-of-the-money-call so
you can allow yourself a little more room to the upside on
the stock.
For example, let's say the stock is trading at $27.00.
Normally, you would sell the 27.5 calls at say $1.00. If
the stock were to rise quickly and eclipse the $28.50 mark,
then with the buy-write strategy, your position would have
maxed out at $28.50, and you would have a $1.50 one month
gain. Not bad, but if the stock went to $29.50 then you
would have missed out on another $1.00 profit. However, if
we had sold the 30 calls for $.30 then we would have
another outcome. You bought the stock at $27.00 and sold
the 30 calls for $.30 and the stock goes to $29.50.
You would have made $2.50 in capital appreciation and $.30
in option premium for a total of a $2.80 return.
So, if you feel the stock has a real good shot at taking a
run up, you can lean your position long by selling an
out-of-the-money call.
If you have a more neutral view on your stock you would
sell an at-the-money-call in order to receive a bigger
premium which allows for greater downside protection if the
stock trades down and higher potential profit if the stock
becomes stagnant.
This strategy also works on the downside. If, by chance,
you feel that the stock may trade down a bit during the
life of the option, then you can sell an in-the-money-call.
The effect of this would be to provide you with a little
extra premium to cover more downside risk.
Remember when you sell an option you seek to capture
extrinsic value. An in-the-money option not only has
extrinsic value but also some intrinsic value.
When you feel that you want to lean your covered call
strategy (buy-write) a little short, choose to sell an
in-the-money call so you can also have some intrinsic value
to cover your downside.
As an example, say your stock is trading at $29.00 and you
feel that your stock may trade down a little but still
remain in an uptrend cycle. You don't want to get rid of
the stock but you also don't want to lose any money so you
sell the 27.5 call at $2.00.
The stock starts to trade down and finishes at $26.00. If
you had owned the stock naked, then you would have lost
three dollars since you owned the stock at $29.00 and it
closed at $26.00 on expiration.
However, because you sold the 27.5 calls at $2.00, you
would only realize a $1.00 loss in the stock. The premium
received will offset the loss due to the fact that you
identified and adjusted for a likely move.
As you can see, the buy-write strategy can be altered to
fit any directional view you have on your selected stock.
Finally, if you intend to use the buy-write strategy
successfully, you generally need to sell the calls against
your stock on a consistent, recurring interval, over a
period of time.
This means that you will have to be prepared to "roll" your
calls out to the next month come expiration. Sometimes, all
you'll need to do is to sell the next month out call.
----------------------------------------------------
Options University is the leading source for options
education for safer investing and better profits. Brett
Fogle, along with Ron Ianieri who was a floor trader for 15
years on the Philadelphia Stock Exchange. Leveraging his
experience, the educational company is uniquely qualified
to teach investors how to make consistent profits while
limiting risk. For more information on Options University
training, visit http://www.OptionsUniversity.com .
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