Truth about options

Mark D. Wolfinger on

Hi, what sort of average returns are their for options and
what are the average probabilities of achieving them? I read
a book where someone proposed using options, covered calls
and the like to have 14-20% monthly returns, which I think
is not possible? But is there a truth regarding the high
gains with options? Thanks!!

    Hello,

    First, although it is possible to achieve the returns you mentioned, it is highly unlikely. And to achieve those results, you must take far more risk than is reasonable.

    In today's option world, the premiums (prices) of options are lower than they have been for much of their history (dating back to 1973 when options were first listed for trading on an exchange). That means that prudent investors should try to achieve returns that are less than they might have been able to achieve some years ago. In my opinion, investors whoa re very conservative, and who choose to write covered calls on stocks such as JNJ or GE should aim for returns of about 1% per month. Those investors willing to own stocks that are still high quality, but not the bluest of the blue chips ought to be able to attain of return of 2% per month.

    As you increase the volatility of the stocks in your portfolio - that means owning stocks of lesser quality, you can achieve higher returns. But there is risk. After all, if stock prices tumble, covered call writing will not be very profitable. You will do significantly better than investors who simply own stocks and do not write covered calls, but there would be no guarantee of making any money.

    I try to earn 2% per month, but do not always achieve that goal. The return you seek is going to be very dependent on the quality of stocks you own. The higher the quality, the less the risk (and the better you can sleep at night), but the lower the possible return when writing covered calls. Lower quality stocks provide the chance to make more money, but they are also prone to losing more money when stocks head lower.

    If you sell calls that are slightly in the money, the chances of earning the anticipated return is going to be greater than 50%. If you understand what is meant by the 'delta' of an option, then the probability that the option will finish in the money (i.e., the option owner will exercise his rights and you will receive an assignment notice to sell your stock at the strike price) is equal to the delta. An option with a delta of 60 will finish in the money 60% of the time. I almost always write call options that are slightly in the money, although many investors write out of the money call options. Their options expire worthless often, but it is impossible to predict (in advance) the amount of profit that the covered call position will achieve.

If you need clarification, please write again.

Mark

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