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Wednesday, November 25, 2009

Selling Theta: 5 Option Write Ideas for a Closed Market

Today is Wednesday November 25, 2009 and I am in a selling mood, not because I am extremely bearish but because I see a potential profit play. I am looking to sell covered calls on some of my holdings. If you're thinking about selling covered calls like me, today may be the day to do it! This won't make anyone rich but it's simple, safe, and may give a couple extra dollars to spend over the holiday's.

In this article I will outline five covered call ideas for Wednesday's trade. The reason I plan on selling covered calls today, is because I am taking advantage of time decay. The amount an option contract decays each day (holding everything else constant) is known as Theta, and is your friend when you're the seller. With the market being open three and a half hours (market closes at 1 PM Friday) over the next four days, option contracts should decay. Premiums should be higher going into the close Wednesday than they will be Friday morning, likewise premiums should be less Monday morning than they were at close Friday. I don't expect too much action Friday, so I am choosing to write my shares out Wednesday.

Since I plan on writing covered calls on my positions anyway, I believe it may be beneficial to get short theta Wednesday versus next week. With some of my positions such as Apple and Google, I may look to purchase back the call if profitable when trade resumes Monday, and wait to write it out again on strength in the underlying. It is very important to take into account brokerage commissions as the margins may be very thin. It is also important to note the strike prices I have chosen are prices I am willing to sell my stock at in case a significant move higher occurs in the market.

The five ideas are listed below using data as of market close Tuesday. The table below shows the company, ticker, call option strike price, current theta (or decrease in the call option contract holding everything else constant), and potential return if stock is assigned at expiration.

Company Ticker Strike Theta Return % Protection %
Apple AAPL 210 -0.115 4.4 1.7
Bank of America BAC 16 -0.013 3.4 4.0
Goldman Sachs GS 175 -0.092 4.0 1.2
Google GOOG 590 -0.245 2.8 1.6
MasterCard MA 240 -0.142 3.4 2.4

To better understand options in general, including this strategy, these percentage calculations, and other option strategies please check out my Simplified Stock Option Trading E-Books. As a shareholder of Bank of America, I use this strategy to sell calls on strength and buy them back on weakness. This allows me to generate income off my shares and lower my cost basis, as the volatility of the underlying stock gives a very nice premium, even on out of the money options.

The list above are stocks which I wouldn't mind holding in my portfolio if they do not get exercised at expiration. These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

This strategy allows for some profits to be taken off the table. This is ideal especially when the market has rallied as much as it has. This strategy will give some protection if the market sells off, as well as provide a return if the market continues to rally. If the stock is not assigned, this strategy is a great way to create additional income for your portfolio. The reason option volumes have surged in the last 5 years is because they are a great way to hedge your portfolio as well as create income off of your shares (see chart here). Keep in mind when using this strategy it is essential that broker commissions are low enough to profit from the position.

Disclosure: Long AAPL December 200 Calls, BAC, GOOG January LEAP 300 Calls

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