The Covered Calls Farm
Planting and Harvesting Covered Calls for Fun and Profit using a Farming Strategy
Building the Farm - An Example
You buy $120,000 in stock and write calls (sell to open) that brings in $20,000 in premiums. Actually invested
$100,000. You write 6 months calls (Buy/Write in June 2010 and calls expire December 2010). If all the stocks stay at the same price as purchased and all calls expire you will earn 20% actual or 40% per annum. (Note: Unusual getting 20% on 6 months except volatile stocks. Actual amount received will depend on the market at the time, the stocks you chose, etc. Goal would be 15% actual. Again, purpose of this example is to describe the concept and how a disciplined covered call strategy might work. )
A. Stocks stay flat. At the end of 6 months your account is now worth $120,000. You sell calls again on same stocks
and are successful in getting another 20% on the $120,000 worth of stock or $24,000 in premiums. At the end of 12 months you have received $44,000 in total premiums. You do it a third time and bring in $28,800 in premiums. This is in an ideal world where all stocks stay flat and premiums remain at the same level at the time of re-write.
B. Stocks Go Up: If all your stocks are higher then the strike price at expiration then all will be assigned in December 2010. There may be a profit or loss on each trade depending on the actual price the stock was purchased vs. strike price written. Let's assume they were exactly the same as the strike price (not likely). In B, the results are the same
as A. Difference is that you would end up with $120,000 in cash in the account (less commissions). If you did buy/writes on the same stocks with the same premiums and 6 month calls would have about the same result as A. You would pay more commissions but with discount brokers should not be a big amount.
Disclaimer: This website is designed to provide educational material related to the covered calls strategy. We do not recommend any specific investment. Also, there are no guarantees that
following the covered calls strategy will not result in
losses or guarantee gains. You need to take the effort to understand the strategy and then decide if
you are willing to learn, apply and maintain the strategy. Farmer Ron
C. Stocks Go Down: You overall portfolio in this example has a 16.67% downside protection based on the total stocks owned ($20,000/$120,000). Or 20% of your actual investment ($20,000/$100,000). So on average you could take a 20% hit and not lose your assets. Of course, any stock could drop below the premium protection for that stock and you will start seeing a real loss on the stock even though your overall average might indicate no loss.
You never know what is going to drive down a stock. While great fundamentals should give you hope that the stock will not take a major hit, there are no guarantees. An unexpected event (like what's happening to BP and Anardarko), or other unexpected reasons can tank your stock. Our goal is to hopefully not have losses but at least help limit the losses
with the covered calls strategy.
You can learn more by going to the Storm Damage section which further develops actions you can take.
Updated: October 31, 2010