A Real Covered Call Option Example...

A covered call example of trading for down-side protection. This example shows how you might purchase stock and then sell covered call options against it over many months, including rolling or managing the call options as the stock price moves over time.

Our example begins... At a time when crude oil prices were at new lows, like $10 per barrel. We anticipated that this condition would not last much longer, although we did not know when it would turn. Prices of oil and drilling companies were also at record lows for the cycle. We investigated several companies to find what we hoped would be the survivors and rebound sharply when prices firmed again. We decided to invest in Noble Drilling Corp. It was selling for around $15 per share. It had been as low as $11, but seemed to be stabilizing. Our main strategy would be to purchase shares near this low, before the price recovery, then write covered calls to earn income in the short term. Note: The covered call is buying shares of stock and selling (writing) a call option against it, so this is why covered calls are sometimes referred to as buy writes.

The stock was weak during the rest of January and most of February likely due to falling crude oil prices and continued cheating by the OPEC countries. Both the stock and the option price drifted lower after the purchase of the shares. With the fall of the option and 6 weeks to go before expiration, we bought back the Mar. 15th CALL to close the position.

The stock held its ground as crude oil prices slowly rose. This seemed an opportunity to write another CALL. At this new stock price, we were able to write the option at a higher strike price.

The stock continued strong and by the end of April hit $20 per share. Our CALL was now selling at a much higher price than our original sale of 1 1/4. With such a strong run in the stock, we would have been better off not doing the last option write in March. However, we did not know this was going to be a sustained upward move in the price of the stock. In an attempt to take benefit from some of the upward movement, we decided to buy back the June 17 ½ CALL then write another in its place. The new option had to be one strike price higher and 3 months out in time (expiration) to avoid losing income on the exchange.

The stock continued to rise over time. By August the stock was near $26 and still looked strong. It was time to roll up in strike price and out in time for the option to avoid having the option exercised in September.

As of October we hold 500 shares of Noble Drilling at a price of $22 1/4 and 5 contracts of the Dec. 25 CALL at $1 per contract. If our shares get exercised at $25 (on Dec. 17th) we will have made 11 3/8 points or $5,687.50. A return of over 75% on our original money in a little less than one year.

And the story continues...