For illustration purposes, assume that we’ve done our analysis and have tentatively decided we would like to write Cisco Systems (CSCO) covered call as shown in Figure 10.5:
|Cisco Systems, Inc. (CSCO) Covered Call|
|Calls:||CSCO Jun 20 Call|
|No. Contracts:||Five (5)|
|Call Bid Price:||$ 1.25|
This trade would involve buying 500 shares of Cisco Systems (CSCO) for 19.75 per share and writing five contracts of the DEC 20 Call at a premium of 1.25 per share ($125.00) per contract.
Before placing the trade, we should first decide the details of the trade plan. Obviously, the trade order to be entered has not yet been filled, so the exact breakeven point and potential flat and if-called returns are not yet known. But our working numbers are close enough for planning purposes. Details such as trade duration, support and resistance do not depend on the fill gotten, anyway.
The trade plan can be just as detailed or sparse as you want to make it –it’s your plan and should be created in accordance with you style and the way you trade. Write it on the back of an envelope, which you can modify to your own trading style. But especially for those learning the craft, recording the plan elements is very helpful in retrospect for doing post-mortem analysis on closed positions. Nothing is more annoying than having to do historical research to get information that could have been jotted down in an instant at the time.
Following is a simple and effective covered call trading plan, with each point explained. Do not fill in all of this information until you have decided the trade is a GO!
|Trade Planning Elements||Stock: Cisco Systems (CSCO)|
|Trade Rationale||Write OTM to capture stock rise off support; industry is healthy||Briefly state the trade strategy, for clarity and for future reference. It helps to note brief impressions about the industry.|
|Call Option||Jun-05 20C
Prem = $1.25
OTM – all time value
|Note the call strike, expiration month, premium and time value, where ITM.|
|Stock Price = 19.75
Call Prem. – 1.25
Net Debit = $18.50
|We enter a net debit limit order. For this hypothetical trade, a ND of 18.50 would yield a premium of $1.25. We can try entering a smaller ND. The net debit is the trade’s breakeven point. Enter actual numbers after fill.|
|$9,250 – Cash
$ -0- Margin
|We intend to buy 500 shares of CSCO at an $18.50 net debit, which equals $9,250.
Margin: we will not use margin for this trade.
|Nominal Return||Uncalled = 5.82%
Called Out = 7.09%
|The anticipated returns on the trade, both flat (uncalled) and called, based on an assumed fill at the net debit order entry price. Change to actual numbers after fill.|
|-Uptrend for 5 mo’s
-Pulling back to 50-MA and trend line; snapback expected
|It helps to note the trend (or range) and any chart pattern forming. These notes also provide a strong key to trade’s logic for reference and later review.|
|-Pulling back to 50-MA and trend line; snapback expected||Is the stock moving with the market, or against? What is the market doing? Very helpful for post-mortem.|
|Support|| + $18.75
|The closest major and minor support levels and their relative strengths should be noted.|
|The closest major and minor resistance levels and their relative strengths should be noted.|
|Volatilities||10-day = 43%
30-day = 38%
IV = 41%
|You need to know how stocks with different volatilities have performed. You especially need to know how IV compared to HV.|
|Trade Duration||26 days||The anticipated duration of the trade, measured from trade entry date through and including expiration date.|
|Stop Loss Point||$18.25||If the stock hits this point, we will unwind or take other action, after checking the news, market and industry, because support (18.75) has failed.|
|Exit Profit Level|| 7 Days = 3.5%
15 Days = 4.5%
|Notes the profit we will accept for unwinding the trade early. This is a highly personal and idiosyncratic decision. Not necessary at all, but some like to do it.|
|August 12||Last date we can own the stock and receive the dividend. If time value is low at this time, we may want to close or roll the calls out to avoid early assignment danger.|
|Earnings Date||Not due during option cycle||Unless you know that earnings are not due, check for them. Low IV does not prove that earnings are not due.|
|News and Due Date||None found||If news is expected on a particular date before expiration, you should know what it is, if a definite date exists. IV is not out of line in this example, thus no news is to be expected.|
|Early Closing Date||None specified||Sometimes a trade must be closed by a known date, as for example to avoid an earnings report or other event. There is no specified closing date for this trade.|
|Open and Close||O ____/_____/_____
|It may seem silly to mention, but note these dates.|
|Final Return||$ _______________
|Obvious, but note your returns in any way that works best for you.|
As a trader becomes more proficient in balancing these various trading concerns, putting the trade plan in place becomes a quick, almost automatic act. These are common-sense things, and are basic to every kind of trading. A blank trade planner that you can print out appears at Appendix 1.
Interestingly, covered call writers I speak with sometimes cannot say what their breakeven, support and resistance are in a trade; nor a stop/roll level. They frequently have no idea what news, if any, is pending on the company. Thorough trade planning nails these concerns as a matter of habit. If this seems like too much work, you are free to customize it to your needs. The more trades one has open, the harder it becomes to keep the details straight; some kind of planner to memorialize this data is very necessary. It is good discipline and good practice.