Ask Mike:
How does your covered call strategy work?

Question:

Richard from NY asks,

Mike,

I just signed up for your 1-month free trial and would like to know a little more information about your covered call strategy. I like to do covered calls and am curious how your strategy might be different and, hopefully, better than mine.

I look forward to using TurnerTrends for the next month during the trial.

Thanks,

Richard

Mike's Response:

Hi Richard,

Welcome! I am delighted that you are giving us a try. I think you will like our covered call strategy. It is a bit different (some would say, 'a lot different') from most covered call strategies.

The traditional covered call strategy has the following objectives:

1. The investor wants to keep a stock for the long term perhaps for years.
2. The investor wants to generate as much income from the stock as possible, including dividends and income from the sales of calls against the stock.
3. The investor does NOT want the stock to be called away, so calls are sold well below what the investor thinks the price of the stock will reach. The investor wants the call to expire worthless, so that they can sell another call against the same stock. The investor wants to repeat this pattern over and over and over.

The above strategy is NOT our covered call strategy. Here is ours:

1. We look for a stock that we believe will appreciate significantly in price by the expiration date.
2. We want the price of the call (the premium) to be at or near the Expected Move (our volatility calculation) of the stock. This means if the stock moves against us and triggers our stop loss, the income generated from the sale of the call will get us out of the stock for little, if any net loss.
3. The key to picking the right stock is selecting a stock with the right combination of volatility, premium, quality fundamentals, expected dividends during the contract, and technical buy signals from the stock, the stock's Industry and the stock's Sector.
4. We want the stock to be called away from us. Therefore, we look for expiration dates that are within our pricing trend average duration, which is between 60 and 90 days.
5. We look for a net return, if the call is exercised, that will generate an annualized return of 25% or more.
6. If the stock moves significantly above our strike price, we will consider buying back the calls and selling the stock, if the net of the trade is greater than the stock being called away from us if exercised.
7. If the stock's price stays below the strike price through the expiration of the contract, resulting in the call expiring worthless, we will most likely sell the stock rather than sell another call against it. The only time we would not sell the stock is if it offers the best covered call strategy we can find at that point in time. Rarely does this happen. We don't want the stock unless it can generate a substantial return over the next 60-90 days.
8. If the stock's price moves against us to the point of triggering our stop loss, we will buy back the calls before selling the stock.

So far, our strategy is working like a charm. Our annualized return is running better than 14%, which is not bad in the kind of market we have been in during the short life of the portfolio. However, this portfolio is only a few months old, so one never knows if it is the strategy or just luck that is producing our strong returns. Time will tell, of course.

Thanks again for giving us a try, Richard. I hope to see you as a long-term subscriber soon!

Best regards,

Mike