How to sell a "covered call" - For Friend 01

Someone ask me how to sell covered call. As this question has general meaning, many people may have same question, so I post here with more detail answers, Hope this will help.

Q:
Ask a dumb question: how to apply "covered call"? from where broker? Thanks in advance.

A:
1. First you need to apply option trading capability in your account from your broker or trading firm. Sell covered call is the lowest level in option trading and has the least risk comparing other option tradings.

2. Option is the proxy of stock, it is a right to buy/sell certain stock in certain time period at fixed price. （ Strick Price）
To sell covered one call you should have at least 100 shrs underline stock. One call contact represents 100 shrs stock. One call contract means you have the right to buy 100 shrs of the stock in certain time frame at fixed price.

Sell covered call is just opposite of buying call.
By selling a call contract to a buyer, you have the obligation to provide 100 shrs of underline stock in certain period of time at fixed price. Since you already have underline stock, so your sold call is "covered" by your stock.

If you do not have stock, you still can sell call, but the call you sell is "naked" meaning the call does not has underline stock to cover. If buyer want to use his/her call contract to buy stock, you have to buy stock from market and provide these shares to the buyer at pre-defined price. （ or contact price.） For example. You sell a $50 August call of ABC stock at $2 and stock price is also $50 at the time. 10 days after you sell the call, the stock price went up to $60, the buyer has the right to buy 100shrs ABC stock from you at $50 regardless current stock price. You have to buy 100 shrs of ABC from market and deliver those shrs to the buyer at $50/shr That is dangerous if you are not seasonal trader.

3. After you done 1 and 2, you are ready to sell covered call. There are two parts to decide call price: 1）Intrinsic value 2） Time value which also related to Implied Volatility （IV） of the stock.

1） Intrinsic value: example: stock price is $50, for $45 call has $5 intrinsic value. （50-45=5）
2） Time value: The longer time period of contract contain, the higher time value of contract will have. Example: stock price is $50, For $50 call, there is no intinsic value but only the time value. August $50 call price is $2, so the time value from now to 8/15/08 （OE day） is $2. For Sep. $50 call it cost $3.

You can sell 1 August $50 call and get $2. By 8/15/08, if stock still has price $50 or under, you get $2 as the call contract expired worthlessly. Since you still own the stock, you can sell next month call again.

The IV plays important role in option price. High IV means stock price moving very quick in either direction. High IV generate high time value of the stock option.

For the covered call seller, the best time you sell the covered call is when IV has spike and option become very expensive. Seller has good chance to get profit. For the buyer, just do opposite of it, buy option when IV is low.

Normally, sell next month covered call is the best interest of seller. Because option time value decay within 30 days increase exponentially.

To calculate option price is rather complex, Fortunately there is a Option Price Calculator which can help you to get estimate option price. （Check end of this post.）

SKF August 170 Call this Morning when stock price at $147


4. Something you should know about selling covered call.

Selling covered call is not risk free operation, in general there are two risks involved in this strategy:
1） If stock fall sharply after you sell covered call, you can not cut loss by selling the underline stock.
2） If stock up significantly after you sell covered call, you can not sell the stock before OE to lock in the profit.

It is not suitable for downside protection, since the premium is limited. For those stocks which has singnificant down side risk, this strategy is not suitable.

It is also not suitable for the stock which has significant upside potential in near term, become it locked up underline stock until OE. Share holders could miss good profit opportunities.

This strategy is suitable most for those stocks which moving in a range and having a positive slop in general.

Option Price Calculator:
http://www.hoadley.net/options/optiongraphs.aspx?divs=Y

(forward from: http://web.wenxuecity.com/BBSView.php?SubID=finance_best&MsgID=11098)

Head and shoulder pattern - Aug 26,2010

SP500 Wave III-1 down started on 8/9 at 1130, wave (3) will be

done tomorrow or early Monday, then (4) up to 1055-60 mid of

next week. The end of wave (5) will be below 950 before

September ends which will conclude wave III-1. Enjoy the ride.

(http://www.hutong9.net/viewthread.php?tid=92222&extra=page%3D1)

Today the market opened high and closed at the low. S&P and DOW

formed a bearish outside day. Nasdaq and Russell back tested the S&H

neckline. The big picture is that market remains bearish, traders sell every

rally. Tomorrow we will have the Q2 GDP second estimate. Market expects

1.4%, but many people think the number is less than 1% all the way down

from 2.4% when it was first reported.

Tomorrow's market guessing - Aug 27, 2010

Today's one news from Forum:

There were massive paper sell orders on the cash close right on 4PM by MS, JP, GS, Chi Corp (used to be ABN AMRO as a lot of people have been private-messaging me asking what Chi Corp is). I counted at least 2000 cars sold (roughly 500 cars each) on the cash close. This is not a good sign for tomorrow. I suspect the institutions are expecting (or already known through their contacts) for a much worse than expected GDP estimate revision.

(http://www.hutong9.net/viewthread.php?tid=92232&extra=page%3D1)

So we expect another down day for tomorrow?

However, according to Cobra, now there is a pattern formed that on bullish reversal day followed by Dark Cloud Cover, which happened previously that indicates tomorrow will be a up day. Let s see.

Candlestick Analysis Today’s Candlestick Patterns: Black Opening Marubozu Bearish Belt Hold Bearish Engulfing

Today a Black Opening Marubozu was formed. This shows that the day opened and prices continuously went down but they did not close at the low of the day and thus they created a lower shadow. For more about this candlestick click here. Bearish Belt Hold Pattern. This is a bearish reversal pattern that marks a potential change in trend. However, its reliability is low and it definitely requires confirmation. For more about this pattern click here. The last two candlesticks formed a Bearish Engulfing Pattern . This is a bearish reversal pattern that marks a potential change in trend. However, its reliability is not very high and it requires confirmation. (http://www.americanbulls.com/StockPage.asp?CompanyTicker=MRVL&MarketTicker=NASD&TYP=S) There are three possible cases of bearish confirmation. You have to follow the session closely to see if these cases will hold or not. The market opens with a downward gap, signaling a bearish sentiment in the first case. Your benchmark will be the opening price. If the prices stay below the benchmark, sell your shares. Any black candlestick with a downward gap is a valid bearish confirmation criterion. In the second case, the market opens at a level, equal to or above the previous day’s close. The benchmark is that closing price. If prices during the session stay below the benchmark, sell your shares. Any black candlestick closing below the previous day’s close is the second confirmation criterion. If, however, in both cases, the prices during the session start going over the benchmark avoid selling. The third case of confirmation is rarely observed. The market opens with a big upward gap suggesting a very bullish day, and the day ends with a black candlestick, but still closing above the previous day’s close. Such a day satisfies the third confirmation criterion and the closing price of the black candlestick is the benchmark. If one of the three confirmation criteria is not fulfilled, or in case of a white candlestick or a doji on the confirmation day, the SELL-IF alert remains valid, however, without confirmation and the three confirmation criteria are then sought in the following day. The only exception is the long white candlestick. Any white candlestick following a SELL-IF alert makes the signal void and invalid. The market looks strong on the short side as evidenced by recent price activity. If the SELL-IF is confirmed, new short selling may be considered

Today's market review and forecast for the near future - Aug 25, 2010

Head and Shoulder Patten. Recently may rebounce and then bearish down.

Summary for the day today: (Mitch King)

After four consecutive down days it is not surprising to see buying kick in

for a snap back rally. The market sold off this morning in anticipation of the

upcoming economic reports, but a bottom was established at the time

reports hit and heavy buying began.

We should see another 1-2 days of buying before more selling occurs. We do

, however, have initial jobless claims and continuing claim numbers tomorrow.

Wall Street will be keying in on this so if the number is substantially greater than

expected, it could spark some selling again.

Therefore, my estimation is: if you bullish, hold it. Bearish, hold it as well, because in recently two or more days , we may see some buying and the market will bounce back, as long as it bounced back, start to short,, because the head and shoulder pattern indicate a short and medium term of trending down.

Chart reading today for index:

VIX: Bearish Engulfing, a reversal signal.

Nasdaq: Bullish Engulfing

DOW: LH,LL with lower volume

S &P: LH, LL, piercing pattern, not sure bullish or bearish.

(http://www.schaeffersresearch.com/commentary/observations.aspx?ID=101925)

In sum, the estimation is : tomorrow market direction mainly depends on the report. 1-2 more days of buying is possible and market may rebounce and then trend down will continue.

Today a Long White Candlestick was formed. This shows that the prices advanced significantly from open to close during the day under strong buying pressure.

A bullish pattern has developed and a BUY-IF alert is issued today. You will see if we erred slightly in the previous SELL signal. A confirmation in the next session may mean that we have underestimated the bullish power of the market. The task is now to confirm the validity of this bullish pattern. We will guide you through this process but the prime star of this game is nobody but you. First you must do your homework. A good starting point may be to keep an eye on after-hours and futures trading to get preliminary hints about the direction of the market. Related news, events, economic data, and the world stock markets should also be closely followed prior to confirmation session.

There are three possible cases of confirmation. You have to follow the next session carefully to check if these cases will hold or not:

The market opens with an upward gap, signaling a bullish sentiment in the first case. Your benchmark will be the opening price. If the prices stay over the benchmark, go long. Any white candlestick with an upward gap is a valid confirmation criterion.

In the second case, the market opens at a level, equal to or below the previous day’s close. The benchmark is that closing price. If prices during the session stay over the benchmark, go long. Any white candlestick closing above the previous day’s close is the second confirmation criterion.

If, however, in both cases, the prices during the session start coming below the benchmark, avoid buying. Sell if you feel a definite tendency in prices to close the day below the benchmark.

The third case of confirmation is rarely observed. The market opens with a big downward gap suggesting a very bearish day, and the day ends with a long white candlestick, but still closing below the previous day’s close. However, such a day satisfies the third confirmation criterion and in this case the closing price of the long white candlestick will be taken as the price of confirmation.

If one of the three confirmation criteria is not fulfilled, or in case of a black candlestick or a doji on the confirmation day, the BUY-IF alert remains valid, however without confirmation and the three confirmation criteria are then sought in the following day. The only exception is the long black candlestick. Any long black candlestick following a BUY-IF alert makes it (the signal) void and invalid.

Do not consider any new short positions given the bullish alert and the recent bullish momentum. Short sellers must cover their positions to prevent further losses, if the market confirms the BUY-IF signal.

(http://www.americanbulls.com/StockPage.asp?CompanyTicker=MRVL&MarketTicker=NASD&TYP=S)

Market Recap:

My observation:

1. This week we will have a lot of reports coming out, and the market will be impacted a lot by these reports results and the direction of the market will be affected by these reports as well. Thursday we will have jobless data and Friday we will have the GDP estimates. Currently the market is still under down trend since Aug 20 " Confirmed Down" by Vectorvest.

2. Today DOW plunged 134 points. A key critical factor is that the existing home sales plunged 27%. My thoughts on this: From last Friday we already know the home sale data will not be good today. That is why in my yesterday's blog I mentioned today's market will possibly down. But the 27% is way beyond expectation!!!!!! Crude futures also collapsed today. An noticeable phenomena currently is that : there is positive correlation between Stock and Oil price. Logic behind this is that if stock market is not good, it will have direct effects on the commodities.

3. My position: I was beaten down by the market!!! Even though the market is down, my position showed strong bullish today with a positive 3%.!!!! with increased volume compared to yesterday and it may seems to be still in the up channel. MACD is up, STO is almost topped, OBV is up channel. My previous strategy for this position is to hold extremely short time ,say 1 or 2 days, as far as the momentum disappear and the price retrace back, I will close the position. Currently it seems that it may maintain its up momentum for a while till it s topped. The current price is still at the UP BB edge.. Therefore, I am playing it a little bit aggressive now,, either hold it for more days or get rid of it tomorrow if the price gap up again or close green. I will keep it posted when situation confirmed the validation of "buy" signal or not.

4. It has been 4 days continuous down, tomorrow it may up.. Greater possibility. This Thursday will be pivot day according to Cobra.. ( maybe an important low day..) Let's watch.

MRVL: 16.22 0.50 (3.18%) - Marvell Technology Group Ltd.

MRVL: 16.22 0.50 (3.18%) - Marvell Technology Group Ltd.

When I opened this position, actually I am checking ATHR and wanted to buy it back since I am looking forward to a bearish market starting from this week and particularly the semi-conductor section is weak. Then I found this MRVL was up almost 10% by the ER. And I thought the momentum of keeping up trend may seem hard especially if the market is trending down. So i changed my pick of ATHR and opened this position. yesterday it went well and today all the profit returned back to the market as MRVL is up today by bigger percent and listed as Today's Big Gainer!!!! While ATHR is under the normal trail and heading down continuously with 3.6% down. I wiped off 150 dollars at least per contract today. A lesson to learn and will keep it up that I should not enticed by some visible signal and should stick to my observation based on TA.

I will still keep close look at this MRVL and see what it will happen tomorrow. Now it s getting hotter and hope not to burn myself because of greedy.

Market Recap: DJIA Breaks Short-Term Support on Late-Day Selling Spree

Market Recap: DJIA Breaks Short-Term Support on Late-Day Selling Spree

No major data today.

Dow: HH, HL, closed in upside down hammer with lower volume. Hit 50MA and pulled back. Bearish.

Nasdaq: Bearish Engulfing with lower volume. Bearish.

S &P: HH.HL,Closed in gravestone with lower volume.Bearish.

VIX: LH,LL, hammer,Bullish.

By the close, all three major market indexes had given back their early gains to finish narrowly below short-term support levels -- opening the door for either an oversold bounce or a fresh wave of selling pressure on Tuesday.

(http://www.schaeffersresearch.com/commentary/observations.aspx?ID=101872)

A chopping day tomorrow?

My position review: MRVL

It s way up at the UP BB. Today it retrace back and closed by 2.72% down, which is expected. It needs to retrace back after such a big up. Currently the whole Tech section is weak by 1.09% down. I need to keep close watch on this one. From the recently two years' data. The price broke up the Up BB, only at the uptrend that the price kept going up.. Currently the price trend for MRVL is down so it s unclear for the particular direction.

MA 7 day is above MA 14, but MA 14 is below MA 25. A little bit unsafe here for the short side. STO is high, MACD is higher, price went down with volume about average. Since this stock is hot now, 1 or 2 more days to watch along with the direction of the market to decide whether to hold it for longer term or close the position. Basically the intermediate term is bearish for the market. And the Hinderberg Omen has got 3rd confirmation. So be cautious.

Calendar (All Eastern times)

Tuesday, 10:00am, Existing Home Sales, 4.75M

Wednesday, 8:30am, Durable Orders 3.1%

Wednesday, 8:30am, Durable Goods -ex. Transportation, 0.5%

Wednesday, 10:00am, New Home Sales, 330K

Wednesday, 10:30am, Crude Inventories

Thursday, 8:30am, Initial Claims, 485K

Thursday, 8:30am, Continuing Claims, 4515K

Friday, 8:30am, GDP - Second Estimate, 1.4%

Friday, 8:30am, GDP Deflator - Second Estimate, 1.8%

Friday, 9:55am, U Michigan Consumer Sentiment - Final, 69.4

It is likely to be negative for that house index.. So it will be not surprising to see the market down tomorrow.