The most powerful force in the Universe – compound interest

Albert Einstein

Prologue

In a previous post, I described two strategies for using Cover-Calls; “1-week strategy” and “1-month strategy”. The 1-Week strategy is for required portfolio adjustments. The 1-Month strategy is to milk little extra premiums on stocks I want to hold long term.

In this post, I want to examine if the 1-Week (non-urgent) cover-calls are indeed effective.

To review some background; late last year I bought 100 shares of Salesforce Inc (CRM) for a base price of $143.27. It was just then getting off the bottom of the Oct-Dec ’19 market correction. Several Analysts agreed that CRM’s price was undeservingly brutalized during the correction and the price at the low $140’s was a good buy… So I did.

Moving forward, CRM peaked up to about $166 then for almost 4 months moved either sideways or trended down. Since my general portfolio strategy is to manage the trend, I decided to sell CRM and buy something that is trending up. (The chart below was what I was looking at. For four months, CRM was trending down. )

9-Month Price/Trend Chart for Salesforce (CRM)

On June 26, I decided to sell CRM and buy MSFT (trending up). My choices were to sell 1-Week, near-the-money cover-calls on CRM until assigned and then buy MSFT – or just immediately sell and buy. I chose the prior – let’s see how I did…

On June 26: CRM closed at $149.05/shares. If I would have sold at that time and bought 100 shares of MSFT at $133.93 then today with MSFT currently at $138.75, I would have improved my portfolio value by $482.00 ($138.75 – $133.93 = $4.82 X 100 shares = $482.00). – But I did not choose to do this…

9-Month Price/Trend Chart for Microsoft (MFST)

Instead, what I did was:
6/27: Sold an ATM cover-call ($150/strike) for $95.55. It expired worthless 6/28.
7/1: Sold a near ATM cover-call ($155/strike) for $15.10. Closed early (see the last post).
7/5: Sold an ATM cover-called ($155/strike) for $90.44. Assigned 7/12
7/15: Bought MSFT for $138.75

So what does this mean:
Instead of selling my shares of CRM at $149.05 on June 26, I wound up selling it for $155.00 on July 12. Waiting for the 1-Week cover-call strategy to assign actually netted me an additional $595.00. For that part – not bad.

I also made $201.09 in cover call premiums between 6/27 thru 7/15. So add that to the $595 for a net portfolio improvement of $796.

But on the flip side, instead of buying MSFT at $133.93 on June 26 I instead bought it at $138.75 on July 15. That delay in buying MSFT lost me about $482 of increase MSFT stock value by waiting to buy.

The end results, the net impact was an improved value to my portfolio of $314.00 ($796.09 – $482). Not a bad profit for 18 days.

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P&L and Performance Status

YTD (2019)

Net Profit = $1,831.51
Started 84 trades: 41 Vertical Bull Put Spreads, 43 Cover Calls 

Profit for Spreads $-296.25
ROC for Spreads (target = 72%):-7.5%
(Note 1: at this point, I expected YTD ROC should be around 35%-ish. I contribute my lack of progress to my still learning the ropes. A lot of the rules, goals and decision points were not defined earlier this year – ha… or even last month…)

Profit for Cover Calls $1,262.83

Last Month (June)

Net Profit: $753.87
Started 15 trades: 6 Vertical Bull Put Spreads (1 still open), 9 Cover Calls

Max $$$ Available for Spreads (Max Risk): $3,960
Profit from Spreads: $330.27
ROC from Spreads (target – 6.0%): 6.9% 

Profit from Cover Calls: $423.60

MTD (July)

Net Profit: $398.50
Started 9 trades: 5 Vertical Bull Put Spread, 4 Cover Call

Current at risk $$$ for Spreads (Max: $3,675): $3,814
Profit from Spreads: $224.25
ROC from Spreads (target = 6.0%): 7.7%

Profit from Cover Calls: $174.25

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Schedule for this Week

Monday:

  • Review and tweak Trend-Channels for all stocks in the watch list.
  • Confirm that the target expiration date for all options trades is 25 days out (4 weeks).
  • By 10 AM, stage possible trades for all watch list stocks (but don’t trade anything).
  • Watch 1 Webcast or take one online mini-course to be completed by Friday.  

Tuesday:

  • Review how yesterday’s staged trades moved. Adjust premiums to take advantage of movement (these are “long-shots”). 
  • Submit a couple of Vertical Bull Put Spreads, but keep a close watch. If one takes, cancel the others (we just want one new active trade). 

Wednesday:

  • If no “long-shot” spreads were accepted yesterday, then readjust premium to ATM prices and resubmit. We want only 1 vertical spread accepted so keep watch.
  • Recheck/tweak trend-channels. 

Thursday:

  • Reset target expiration date to 29 days out (the following Friday). 
  • By 10 AM, stage possible trades for all watch list stocks. 
  • Submit a couple of Vertical Bull Put Spreads, but keep a close watch. If one takes, cancel all others. 

Friday:

  • Same as Wednesday.
  • Update trading journal (this blog) and update it to the Internet by end of the day.
  • Make sure you watched a webcast.
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Trades Ended 7/12/19

CRM: 155cc – 1 contract – Open 7/5 – Closed 7/12 – Premium Collected = $90.55
This contract was assigned on 7/12. Closing price = $158.08. (See Prologue above)

QQQ: 171 Put – 2 contracts – Open 6/18 – Expired 7/12 – Premium Collected = $49.07
The short-leg of this spread was closed early last week due to the VP Pence’s recall.

DIA: 256 Put – 2 contracts – Opened 6/18 – Expired 7/12 – Premium Collected = $29.07
The short-leg of this spread was closed early last week due to the VP Pence’s recall.

Trades Still Cooking

Current dollars at risk for Spreads (max $3,675): $3,814 (96% of max)

AMD: $36cc – 4 contract – Open 6/26 – Expires 7/19 – Net Premium = $49.05
When Opened: Probability of OTM = 93.5%, Head Room = 20.5%. 
Now: Probability OTM = 91.0%, Head Room = 8.8%
(Note: the HR for this trade is now less than half it was when open. Current Exit-Rules states that I consider closing this early. Since I am less than a week to expiration and the probability of expiring OTM is still in the 90s%. I’ll keep a close watch…)

SPY: $280p/$270p – 1 contract – Open 6/28 – Expires 7/26 – Net Premium = $82.00
When Opened: Probability of OTM = 80.5%. 
Now: Probability OTM = 97.1%

QQQ: $183p/$173p – 1 contract – Open 7/3 – Expires 7/26 – Net Premium = $54.05
When Opened: Probability of OTM = 82.0%. 
Now: Probability OTM = 94%

DIA: $257p/$247.5p – 1 contracts – Open 7/5 – Expires 8/2 – Net Premium = $56.05
When Opened: Probability of OTM = 81.9%. 
Now: Probability OTM = 94.4%

IWM: $150p/$148p – 2 contract – Open 7/10 – Expires 8/2 – Net Premium = $41.05
When Opened: Probability of OTM = 78.4%
Now: Probability OTM = 78.4%

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New Trades for This Week

This week’s Schedule and goals:

  • 1 vertical bull spread by Tuesday.
  • 1 vertical bull spread by Thursday.
  • 1 1-month cover call by Friday
  • 1 1-week cover call (CRM) by Monday (see “Trades Ended 6/28/19”)

Note: Only 1 Spread trade this week (see below) due to my self-imposed max at-risk amount of $3,960. Once this trade was completed, I had $3,814 already at risk.

Additionally, I did not make any Cover-Calls this week.

QQQ: Net Premium = $31.05, Max loss = $362, ROC = 8.6%
When Opened: Probability of OTM = 83.0%

QQQ: $185p/$183p Vertical Bull Put Spread
2 contract – Open 7/16 – Expires 8/9

For the past 7 months, QQQ has been on an upward trend. The exception was about 6 weeks starting mid-April after Trump tweeted about the US/China trade deal. But it had resumed the same growth pattern shortly thereafter. The short strike at $185 (red horizontal line) is well below the trend channel plus, an additional bonus, it is slightly below the 68% Probability of Expiring Cone.

This is not a big moneymaker, but it is above the 7.5% ROC minimum and currently a low-risk trade.

AMD $41cc – 2 contracts – Open 7/19 – Expires 8/9 – Net Premium = $30.05
When Opened: Probability of OTM = 93.6%. HeadRoom = 24.7%%

AMD $41 Cover-Call
2 contracts – Open 7/19 – Expires 8/9

AMD has its quarterly conference call on 7/30 – 3 days before this cover-call expires. Since conference calls have been known to dramatically affect stock prices, I am a little leery about starting this trade.

However, the 41 strike price is well above the trend channel. The HeadRoom (HR) of this strike price is 24.7 % (stock price will have to rise 24.7% within 21 days to be ITM) and the probability of expiring OTM is > 93%. I would be THRILLED if AMD did skyrocket to $41, but if it didn’t $30 buys lunch.

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Epilogue

Can you think of cover-calls’ premiums as a mechanism to lower the underlining stocks’ cost basis? Consider this analogy:

I go to Bestbuy and buy a new TV for $1,000. So $1.000 is my cost basis for the new TV. But when filing away the receipts I find a sales ad that says “10% off all new TVs at Bestbuy”. So I head back to the store and show them my receipt and the sales ad I found. Shortly after I leave the store with $100 in my pocket. Question: did I make a $100 profit from my new TV? or did the cost basis of my TV change to $900?

The IRS considers premiums collected from cover-calls as short-term capital gains. I have to pay income tax on all these premiums as if it was ordinary income. So from the IRS’s point of view – its profit. But the answer to the question above is – “my new TV cost me $900”.

The two perspectives don’t quite meet in the field of taxes. But one can think of cover-call premiums as a way to reduce the cost basis of the underlining stock.

As an example, consider that I bought CRM late last year and since then I completed 8 cover calls – until assigned. I can view the premiums collected in lowering the cost basis as shown in the table below.

CRM
Trans-DateShares PurchasedPrice/sharePremium from Cover-CallsCost Basis
8/28/201848$152.00 143.27
1/4/201952$135.21 
1/14/2019  $53.54$142.73
2/14/2019  $44.55$142.29
3/13/2019  $28.55$142.00
4/15/2019  $32.55$141.68
6/4/2019  $22.55$141.45
6/27/2019  $95.55$140.50
7/1/2019  $15.10$140.35
7/5/2019  $90.50$139.44
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Since I made $382.89 from premiums, I could consider that I lowered my cost basis from $143.27/share to $139.44/share. Although this has nothing to do with how taxes are calculated, I wonder what it would take to get the cost basis of any of my holdings down to zero???

Cheers…

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