Ken Larsen's web site - Stock Market

      

I've been dabbling in the stock market since 1975.  I buy exclusively individual stocks and shun mutual funds as I'd rather manage my own money.  Being retired, I also have the luxury of time to do it.

 

My favorite stock market web sites

http://finance.yahoo.com/

Stock quotes

http://screen.yahoo.com/stocks.html

Yahoo Stock screener

 

My stock picks for 2016

 

Click here to see my current stock picking strategy.

 

Covered Call Options

My latest strategy is to sell "covered call options" against the stocks that I own. An "Option" is a contract to sell or buy 100 shares of a stock at a specified price (called the "strike price") at a particular date (called the "expiration date") in the future.  Many (but not all) stocks have options associated with them. 

 

In October 2003 I decided that I would use the Options market to generate income for myself.  I would henceforth only buy stocks which had options, and I would sell options for the stock that I owned.  Such options are called "covered call options" or "covered opens".

 

To decide which options to sell and what price to sell them at, I consult http://finance.yahoo.com/   I use this web site look up the current price of a stock or option.   For example, to look up the current price of Microsoft, I type in its symbol, MSFT, and click on "Go".  Up to ten symbols may be entered at once.  Note:  the prices shown are delayed by 20 minutes.

 

To look up the available options for a stock and their current bid/ask prices, I look up the current symbol and then click on "Options" (near the upper left-hand corner of the screen).  I then click on the month that I want the option to expire (e.g. Jan 05).  If I know the symbol for an option (e.g. ZMFAZ.X for Microsoft January 2005), I can enter that directly and then click on "Go".

 

I like to pick an expiration date that is 12 months out.  That gives me the best reward as far as option price and strike price.  The downside is that I cannot do anything with the stock once I've sold a covered option (aka "covered open") until the expiration date.  If it quadruples in price, that's too bad.  I'm locked into the strike price until the option expires.

 

I prefer to sell options that have a strike price which is above the current price of the stock.  This strategy gives me a win-win situation:  I immediately reap a profit from the sale of the options.  Then, on the expiration date, I stand to reap an additional reward if the stock is trading higher than the strike price.  If the stock fails to reach the strike price, then I get to keep the stock and sell more options against it.

 

I prefer not to sell an option at a price of less than $ .60/share.  Selling a covered call option ties up the stock until the expiration date, and I personally need more than $ .60/share to justify tying up my shares for a potentially long time.

 

For each 100 shares that I own, I'm entitled to sell 1 "contract".  For example, if I own 400 shares of Microsoft, I can sell 4 contracts.  The return I immediately reap is 400 times the option price minus commission.

 

Option selling has nice tax consequences.  The proceeds from an options sale may be "short term" or "long term" capital gains.  If the option expires worthless, I get to keep the stock, and the option sale proceeds are regarded as "short term capital gains".  If the option expires "in the money" (i.e. above the strike price), the stock will be sold at the strike price.  The proceeds from the original options sale gets added to the sell price of the stock.  Whether the gain is long term or short term depends upon how long I've held the stock.  If I held it more than 12 months, then it's a long term capital gain; if less than 12 months, it is a short term capital gain.  In either event, I don't report the option gain on my tax return until after the option expires!  So, if the option expires in January 2005, I don't need to report it until I file my 2005 tax return - which is in 2006!

 

Before you commence options trading, you must sign a waiver form with your broker acknowledging that you understand the risks of options trading.  He'll send you the form and a lengthy document explaining all the nuances of options trading.  You should advice him that you intend only to sell "covered options".  This is the most conservative strategy, as it has very little risk, because you'll only be selling options for which you own the stock.  Many people sell options for which they do not own the stock.  This is extremely risky, but can reap high rewards.  Nonetheless, I do not recommend it.

 

Example: (from February 4, 2004)

 

Let's say I own 400 shares of Intel (stock symbol= INTC).  At the close of the market on February 4, 2004, Intel shares sold for $ 30.02.  These 400 shares have a total market value of 400 x $ 30.02 = $ 12,008. 

 

Various call options for Intel are:

 

Expiration date

Strike Price

 

 

(A)

Last sold for

 

 

(B)

Immediate reward

400 x B

 

(C)

Maximum possible 

stock gain

400 x (A - $ 30.02)

 (D)

Total gain

(maximum)

 

 

(C + D)

Mar 19, 2004

$ 32.50

$ .50

$ 200

$ 992

$ 1192

“

$ 35.00

$ .15

$ 60

$ 1992

$ 2052

“

$ 37.50

$ .10

$ 40

$ 2992

$ 3032

“

$ 40.00

$ .05

$ 20

$ 3992

$ 4012

Apr 16, 2004

$ 32.50

$ .95

$ 380

$ 992

$ 1372

“

$ 35.00

$ .35

$ 140

$ 1992

$ 2132

“

$ 37.50

$ .20

$ 80

$ 2992

$ 3072

“

$ 40.00

$ .05

$ 20

$ 3992

$ 4012

July 16, 2004

$ 32.50

$ 1.70

$ 680

$ 992

$ 1672

“

$ 35.00

$ 1.10

$ 440

$ 1992

$ 2432

“

$ 37.50

$ .60

$ 240

$ 2992

$ 3232

“

$ 40.00

$ .35

$ 140

$ 3992

$ 4132

“

$ 42.50

$ .20

$ 80

$ 4992

$ 5072

Jan 21, 2005

$ 32.50

$ 3.50

$ 1400

$ 992

$ 2392

“

$ 35.00

$ 2.25

$ 900

$ 1992

$ 2892

“

$ 40.00

$ 1.10

$ 440

$ 3992

$ 4432

“

$ 45.00

$ .55

$ 220

$ 5992

$ 6212

 

Notes: 

1.        The above figures ignore commissions.

2.        Rows in yellow satisfy my criteria of a sell price greater than $ .60.

 

In this example, which option should I sell, if any?  It depends on my belief as to what Intel is going to do over the next 12 months:

 

Scenario

My belief (hypothetical)

Recommended strategy

1

Very negative - I believe that Intel will drop considerably and quickly.

Instead of selling options, I should immediately sell my Intel shares.

2

Somewhat negative - I believe that Intel will drift slightly lower or be flat over the next 12 months.

I'd go for a "high immediate reward" - sell a January 2005 $ 32.50 option and pocket an immediate $ 1400.

3

Ambivalent - I might feel this way if Intel had been sitting in my portfolio for a long time and hadn't done anything.  I might like to get rid of it just to use the money to buy other stock.

If I wanted to get rid of Intel quickly I might either immediately sell the stock or sell a March 2004 $ 32.50 option - or even sell a March 2004 $ 30.00 option.  The above table doesn't list options below $ 32.50, but they do exist.

4

Somewhat positive - I believe that Intel will rise slowly over the next 12 months.

Sell a January 2005 $ 40 option and pocket $ 440 immediately. 

5

Very positive - I believe that Intel may rise above $ 40 by next January.

Sell a January 2005 $ 45 option and pocket $ 220 immediately. 

6

Extremely positive - I believe that Intel will rise significantly over the next 12 months -maybe getting as high as $ 60.00/share.

$ 60 is well above the $ 45 January 2005 options, so I should forego writing any options - just sit on the stock.

 

When should I sell options?

 

Unless you have insider information (and are willing to risk a fate like Martha Stewart!), you pretty much have to rely on gut instincts and historical trends to tell you when to sell.  Ideally, you would like to sell options when your underlying stocks are near their annual peaks. 

 

December 6, 2004 update:  Intel stock plummeted in 2004 to as low as $ 19.64 before rebounding somewhat to its current $ 24.01.  In retrospect, scenario #1 played out.  Unfortunately I didn't have the foresight to predict that. 

 

ishares strategy

June 2008:  After watching the vertiginous rides of some of my stocks (e.g. Garmin and Crocs) I'm inclined to favor buying ishares/ETFs instead of individual stocks.  Under this scheme I recommend that the average investor buy ishares when the S&P 500 index is, say, 15% below its high and sell them when the S&P 500 is near or above its high.  You could additionally sell options against those ishares.  There are a large variety of ishares ... some tied to the S&P 500 or other indexes; some are tied to gold or real estate.  They're safer than individual stocks.

 

iShares which appeal to me:

 

Type

Name of Fund

Symbol

Small Cap

Russell 2000 Value Index Fund

IWN

Mid Cap

S&P Midcap 400 Value Index Fund

IJJ

Large Cap

S&P 500 Value Index Fund

IVE

Energy

S&P Global Energy Sector Index Fund

IXC

Real Estate

Dow Jones U.S. Real Estate Index Fund

IYR

Specialty

Dow Jones Select Dividend Index Fund

DVY

Dividends S&P 500 Dividend SDY
Telecomm Dow Jones U.S. Telecom IYZ
Gold iShares COMEX Gold Trust IAU
Silver iShares COMEX Silver Trust SLV
Japan MSCI Japan Index Fund EWJ
China Large cap ETF FXI
  U.S. Technology IYW
  U.S. Home Construction ITB
  U.S. Oil Equipment & Services IEZ
  U.S. Oil & Gas Exploration + Production IEO
  U.S. Financials IYF
  Biotech IBB
  U.S. Basic Materials IYM
Solar Solar ETF TAN
Wind Wind Farm ETF FAN

 

 

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