Why Weekly Options Work as Covered Calls
Dr. W. Edward Olmstead is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The basic goal of the covered call (buy-write) trade is to generate an income stream by selling short-term, out-of-the-money calls against long positions in stocks or ETFs. In the past, this typically has been done by repetitively selling monthly calls. Now that many stocks and ETFs have weekly options, new possibilities are available.
Let’s look at some of the potential advantages to executing the covered call trade by selling weekly, out-of-the-money calls:
(i) The income generated by selling four successive weekly calls will often exceed that received from selling one monthly call.
(ii) There is flexibility to adjust the strike price of the short call on a weekly basis. If the price of the underlying stock has moved up close to the strike price of the expiring weekly call, then sell a call with a higher strike price for the following week. This allows you to fully participate in the uptrend of your stock while collecting premium from the short call.
(iii) When selling monthly calls, it often happens that the short call is deep- in-the-money when the expiration date arrives. In such situations it may be unwise to either buy back or roll the call for a significant loss in order to retain possession of your stock. When selling weekly calls, this issue becomes less crucial. The expiring weekly call may be only slightly in-the-money, in which case you can frequently roll up by one or two strikes for the next week at no cost, other than trading fees, while making only a one week commitment to remain in the trade.
(iv) If you have sold a monthly call and the price of the underlying stock soon begins a significant pull back, you may be tempted to hold the position for three or four weeks in order to collect the total premium received from the short call. If you have sold a weekly call, the total premium is collected in eight days or less and you are better placed to exit a losing stock position in a timely manner.
(v) When selling weekly calls, you will be making weekly adjustments to the trade. Then it makes sense to gain some extra leverage in the trade by replacing the underlying stock with a relatively cheap synthetic position, such as a deep in-the-money call that expires in six to eight months. This frees up trading capital that can be used for additional covered calls trades in a more diversified portfolio.
The principal disadvantage to doing covered calls by selling weekly, out-of-the-money calls is that the trade requires more monitoring. Of course, there could even be some benefit to being more consistently attuned to the price movement of the underlying stock.
There are currently well over 100 stocks and ETFs that trade weekly options. Popular stocks that have weekly options include, Apple (NASDAQ: AAPL), Facebook (NASDAQ: FB), Google (NASDAQ: GOOG) and Johnson & Johnson (NYSE: JNJ).
AAPL recently won its lawsuit against Samsung and is moving to new highs on the news. Volume in its weekly options is very heavy. There have been over 25,000 contracts traded just today in the 680 weekly calls, betting today's price jump will hold at least through Wednesday when those weekly options expire. Despite fears that a ruling in favor of AAPL may negatively impact Google, which makes the Android operating system used by Samsung, option action in GOOG is far lighter.
We have written extensively about Facebook in our blog, including various strategies to recover your losses on FB at little or no cost, using longer-term options. Weekly options may offer one more way to potentially generate an income stream on this volatile stock.
JNJ stock is not a big mover. Without a catalyst, volume in the JNJ weekly options is relatively low compared to its monthly options and certainly far lower than the more volatile tech stocks. Volume is always an important factor when trading options, so be aware of that when comparing weekly vs. monthly option trading opportunities.
Heavily traded index ETFs with weekly options include SPDR Dow Jones Industrial Average, iShares Russell 2000 Index, PowerShares QQQ and SPDR S&P 500. Your broker should be able to provide a complete list.
Dr. Olmstead can be found at http://www.olmsteadoptions.com, an on-line options trading site, centered around options education material and option trading strategies he’s developed. He is Professor of Applied Mathematics atNorthwesternUniversity, author of the popular and highly-praised options book, Options for the Beginner and Beyond (2006) and former chief strategist for The Options Professor on-line newsletter, distributed by Zacks.com and Forbes.com.
OlmsteadOptions has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Amazon.com, Facebook, Google, Johnson & Johnson, and Qualcomm. Motley Fool newsletter services recommend Amazon.com, Apple, Facebook, Google, Johnson & Johnson, and Yahoo!. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.