Information on Rates of Return

The following post is a good explanation of some of the possibilities with Writing Covered Calls. It came from a student, and has valuable and current information of Generating Monthly Income. If you need more information, go to wadecook.org and get the FREE 11 Mini-Lessons, called Pathway to Profits.

Hey Joe (As sung by Jimmy Hendrix),
QUESTION: What is the average rate of return you shoot for?
That is a great question. There is no set percentage, but here are a few thoughts:
1. The amount of the option is primarily based on speculation. The more volatility, the higher the price.
2. The other main component of an option price is the time to expiration. Do you see how already it would be hard to determine a price that fits all.
3. However, one thing is certain. You or any Call Writer can determine the price of the option before entering the trade. That part of the equation is fixed in time. The only real uncertainty is the underlying movement of the stock.
4. I've written before on price movement—the relationship between the stock and the option—and it is a most interesting area of study.
    A. For example, we look for a stock that moves up, say, 50¢ to $1 every few days, and then back down about the same.
    B. This would be totally different on a $5 stock as compared to a $98 stock. So we look for about a 6% to 10% move, up and down, in the stock.
    C. If we use a $10 stock and there is a 10% move or so, that will produce about a 10% cash on cash return. Likewise, if there is a 5% movement in the stock, that would produce a 5% return.
5. Now, add to this the time to expiration, and the percentages change. What if you only get a 3% return for one week, the time to expiration. But on the same stock, the 5 to 6 weeks out option (the next month), could produce a 9% cash on cash return.
EXAMPLE—Perhaps an example will help with understanding this. MRO, Marathon Oil is at $13.30. The June $13 call options—30¢ in the money—are 80¢ X 90¢. Do you see the 80¢? Of that amount 50¢ is time-value, and 30¢ is in the money. You may want to look at the $14 calls.
Now look at the July's. Same strike price. The $13 calls are $1.20 X $1.30. There's your question: (if you choose to do this trade—that's between you and your broker) Which strike price do you sell? Do you see that this is also a lifestyle choice. How busy are you? In theory, you take what is on the table, NOW. Next month will always be there. Most people are after monthly income.
The July $13 calls at $1.20 to sell, is the point I've been trying to get to. Yes the stock is 30¢ in the money, and that is okay—we have sold away everything above $13. Hint: That's one reason the $14s, either month, look enticing.
What is the percentage of $1.20 on $13.30. It's not 10%, but close at 9%. That is a six week trade. So, again, we look at the chart and see this stock moving every day. It definitely moving, and with an upward bias. We like that.
6. And we haven't even brought up margin. What changes in these numbers if we only have one-half on the money put up, the percentage jumps to 18%.
    A. Margin investing occurs when your account is extended, meaning the money is invested.
    B. Most new investors get 50% margin capability. Actually is would be better to say, 2 times, the amount of cash you have in the account.
    C. If you put $10,000 into your account, you will have buying power—or margin availability— of $20,000.
    D. In our example, if we buy 1,000 shares of MRO, that would be $13,300, and if all of the cash is available, the money will go to that purchase first.
    E. You would then have $6,700 available. Again, we call that "buying power." Yes, you can use that term with your broker. "How much buying power do I have?"
    F. Now, let's say you want to buy 1,000 shares of OAS at $10.30. You can't with the current amount in your account. You'd either have to bring in more money, or buy less stock.
    G. Think of it. 1,000 shares at $13.30 and 1,000 shares at $10.30 is $23,600. You put in $10,000 and have buying power of $20,000. You're short.
    H. Now I want to make a quick point. After you have more experience and more cash in your account, you may be able to get your margin requirement to 30% instead of 50%. In short, this means $10,000 will buy about $30,000 worth of stock. This is not a recommendation, but just FYI.
    I. Don't abuse margin. It is a form of debt, using the stock as collateral. If the stock goes down, you may have a margin call—meaning you'd have to bring in more cash or securities to beef up your collateral.
There is a section on Margin Investing is Paid to Trade.
7. We also didn't the buy-back and maybe doing more than one trade a month. What would that do to your rate of return?
    A. Say you sell the July $13 calls for $1.20, taking In $1,200, then you buy it back in two weeks for 60¢. Then on the next rise you sell the same option for $1.30. That would be awesome, and should be a targeted strategy for anyone wanting more income.
SUMMARY: This was a long way to answer your question. In short, you can look for and get the rate of return you want, or you can take your ball and mitt to another field, choose another stock, and make it happen there.
We shoot for 3% to 5% without margin, and around 8% on margin. It's a target and worthy of using and shopping around to make it happen.
Stock MarketWade Cook