On Monday, November 9, we wrote about a Monday Morning Program member who lost $232,407.50 in a $500,000 portfolio when the Novavax (NVAX) shares which she bought because the premiums on covered calls were attractive. She paid over $174 each and they quickly dropped by over 50%.
Every Monday, she sold just out-of-the-money covered calls on NVAX with expiry date on Friday of the same week.
After 13 weeks, ending on November 2, she brought her losses from $232,407.50 down to $26,341.25.
Writing covered calls and cash-secured puts is risk-free. Immediate cash in the investor’s pocket. A bird in the hand. Any risk entirely derives from ownership of the underlying security connected to the transaction.
Our member continued to write covered calls on NVAX every Monday with expiry date of Friday of the same week. When her shares were called away, she bought them again, albeit at a higher price, in order to continue writing cover calls and receive their attractive premiums. (Two times, when the shares dropped sufficiently in her view, she bought more to bring down her average per-share cost.)
One of our members, A. K. DDS, stated that his only concern was that as the markets edged higher, she lost the opportunity to participate in that growth. Indeed, investors selling covered calls limit their upside on the underlying security; they do so in exchange for the option premium.
More than 2,500 years ago, Aesop taught us that a bird in the hand is worth two in the bush. The options premium is a bird in the hand.
As a variation on this theme, investors can choose to write covered calls a little further out of the money. They will get a smaller premium than they would writing covered calls just out-of-the-money, but they can participate in some of the growth of the underlying security if it takes place.
Last Monday, November 9, our intrepid investor did precisely that. She wrote covered calls with a strike price of $102 instead of her usual just out-of-the-money position. She received a premium of $9,100 immediately with a possible additional amount of $10,000 ($3.00 times 3,500) if the stock reached $102 by Friday, November 13. As we stated above:
As it happens, last Friday, NVAX closed at $96.60. The two in the bush were not there. Just out-of-the-money premium would have given her nearly twice as much as she got.
This experience underscores another market truism. We can always choose better investments with hindsight.
She did, however, trim her losses on NVAX to $17,241.25 ($26,341.25 minus $9,100).
What are her plans later today when the market opens at 9:30 AM Eastern time?
When the market opens today at 9:30 AM Eastern Time, she plans to sell 35 covered call contracts on NVAX at a strike price of $100.00 and expiry date this coming Friday, November 20 (NVAX C 20NOV20 100.00).
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