Hedge Fund
McMillan Analysis Corp - Covered Call Writing: Rolling For Credits
Also known as the incremental return concept of covered call writing, this form of selling options against stock that is owned has several benefits that most investors don't realize. The goal of this strategy is to allow stock appreciation for a block of common stock between the current price and a selected target sale price, while also earning an incremental amount of income from selling options. The target sale price can be substantially above the current stock price. The typical investors positioned for this strategy are those with large stock holdings, interested in increasing current income, and wanting to refrain from selling the stock near current levels.
McMillan Analysis Corp. has proprietary software that analyzes such situations, and can present the client with scenarios outlining how the strategy would do under volatile stock movements. The worst case scenario occurs if the stock climbs straight to your target in a relatively short time period. For example, assume 10,000 shares of General Electric common stock are owned and a target price of 45 is agreed upon. With GE currently trading at 33, we can project what the options would sell for at various points along the way if GE rose swiftly from 33 to the target price of 45. The Black-Scholes model needs several inputs to perform the proper projection. While dividends, time assumptions, and price targets are all essential, the most significant is volatility since that is such an important factor in determining an option's price. GE's current implied volatility of 21% is in the 5th percentile of the past 600 trading days, so using 21 % for projections would be a very conservative estimate considering that it is usually higher than that. An increase in implied volatility would be beneficial to the strategy because then larger premiums could be attained along the way, but by using this conservative estimate to begin with, it fits well with the "worst case" scenario.
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