know your options: Covered call writing

I have a long term portfolio of blue chip stocks which I have owned for years and do not intend to sell whether they go up or down.

I am considering selling calls against the stocks with the rationale that if the stocks stay the same or go down, I will make a profit on the calls and will lose only if they
go up, but this is only one-third of the time.

What is the optimal strategy in selecting calls to sell on the stocks to maximize profits on the calls only, neglecting what the stocks do as I would suffer the losses or gains on the stocks anyways. Should in the money, at the money, or out of the money calls be sold? How far in the future should the calls expire? What additional percentage profit, if any, should one expect to gain from call writing against an established portfolio and are there any studies that support the data?


Hello Richard,

The data you want to compare is the performance of the BXM (CBOE buy-write index) with the SPTR (S&P total return - that's the S&P 500 with dividends) - yes, studies are available that show that covered call writing: 
  • Reduces portfolio volatility
  • Returned slightly more than buy and hold over the past 18 years.
As you already understand, this method is quite beneficial when markets do anything except rise strongly.  Thus, it's a winning strategy most of the time.

But most covered call writers have a different objective than you do.  To me, being assigned an exercise notice and selling my shares is a victory.  You want to continue to own your stocks, and that requires a modified approach.

To maximize profits, you want to sell the ATM (at the money call).  The downside to that approach is that you are forced to buy back many of those options as expiration day nears - to prevent being assigned an exercise notice.  That's not really a problem because you can roll the position (repurchase the call you sold and - in a spread transaction - write a new option).

To minimize the chances of being forced to roll, sell OTM (out of the money options).  Obviously, this does nothing to help with one of your objectives - maximizing profits - but it does make writing covered calls more convenient because less work is involved when expiration day nears.

If you have the time and inclination to closely monitor your positions, then I strongly recommend selling ATM options - unless you believe you have good market timing skills.  If you do (II don't) then you can decide each time whether it's best to sell ATM or OTM.  If you are too busy to pay close attention, then it's simply prudent to settle for less profit and write OTM options.  I don't man very far OTM, but with a stock trading at 32, the 35 call is appropriate.

ITM options are for conservative writers who are willing to let go of their stocks, and is not for you.

Which month to sell: In general maximum annualized profits occur when you sell the front-month options.  this assumes you use a deep discount broker and commission costs are minimal.  But, when implied volatilities are high, as they are now, then there is a lot to be said to writing options with a longer lifetime.  Perhaps 3 months.  I'd even sell 6-month options if I thought options were priced high enough - and that means a high implied volatility.

How much you can earn is impossible to say.  If your portfolio looks like: GE, ABT, JNJ and other 'stogy' stocks, if you can make 2% per month, you would be doing well.  If you own very volatile stocks you can earn MUCH more.  I know of no studies that support this specific data, because the portfolio makes all the difference.


Mark D. Wolfinger
Create Your Own Hedge Fund: Increase Profits and Reduce Risk with ETFs & Options