Selling Covered Calls
Question - Covered Call Selling and Expiration Month
When selling covered calls, how many months out should you go?
Answer
First, for a complete review of writing covered calls, please see the Covered Calls page.
The quick answer is 1-2 months, but it's a good idea to consider the factors, variables, and potential trade offs involved in covered call writing. The expiration month is only one such variable a covered call writer must choose.
Although I personally employ a customized call writing technique as part of my long term Leveraged Investing approach, most call writers are primarily income traders who have no attachments to their underlying stock positions and are perfectly willing to part with them should the short calls be exercised.
Option sellers earn their income from the time decay of options, and the nature of stock options is that the closer they get to expiration, the more quickly they lose value.
In order to maximize your income then, you'll want to sell near term calls because that's where the higher rates of premium decay occur.
Selling calls farther out may bring in a higher amount of premium in total dollars, but when factored on a daily basis, near term calls produce the highest annualized rates of gain.
Calculating Covered Call Rates and Returns
Covered call income rates are very easy to calculate. When considering selling covered calls, take a call's time value, subtract your commissions (both what it cost to set up the trade as well as what it would cost if the call is exercised) and then divide this by the number of days until expiration. That's your daily rate of return.
And to get an annualized figure, take your daily rate of return, multiply it by 365, and then take that figure and divide it by the amount you spent purchasing the underlying shares.
The front month options should always have a higher daily rate of time decay, but sometimes, depending on the situation, if you're only writing 1 or 2 contracts, when you factor in commissions, you might actually have a higher annualized rate writing a little farther out such as 2 months out.
There are many other factors involved when it comes to successfully writing covered calls. You can do a lot to make the strategy more effective and less risky. Covered call writing is deceptively simple but there's more to it than meets the eye. That's why I recommend a subscription service like CallWriter for those who are really serious about selling covered calls for income. Simply put, CallWriter has the tools and resources you need, and educational material second to none.
