Isn't this just a retarted strategy...

[Shhhhh]

Hello all,
I've been talking with some friends who like me are fairly new to options working out simple strategies etc. etc. Here is the strategies one of them suggested. I seems incerdibly risky and dangerous. I'm very interested in your thoughts...

OK, You pick a stock that historically has high volatility (namely a tech stock.) in his example he used Apple.

You buy 100 Shares of AAPL, And write a Deep ITM covered call leap (Jan 2010) for strike of $90. Which closed Firday with a bid of $81.75. Which if held till expiration would result in a net profit of $1071 on the trade. Then you take the $8000 premiums to do shorter term covered calls for may/june.

Something just doesn't seem right about this. What do you folks think? Is he on to something?

Thanks for your input!

[aiki14]

Hello all,
I've been talking with some friends who like me are fairly new to options working out simple strategies etc. etc. Here is the strategies one of them suggested. I seems incerdibly risky and dangerous. I'm very interested in your thoughts...

OK, You pick a stock that historically has high volatility (namely a tech stock.) in his example he used Apple.

You buy 100 Shares of AAPL, And write a Deep ITM covered call leap (Jan 2010) for strike of $90. Which closed Firday with a bid of $81.75. Which if held till expiration would result in a net profit of $1071 on the trade. Then you take the $8000 premiums to do shorter term covered calls for may/june.

Something just doesn't seem right about this. What do you folks think? Is he on to something?

Thanks for your input!

First thing that comes to mind is you can't write 2 calls on 100 shares, and you would have the shares tied up for 20 months. The profit is around 6.25% of the money invested over that time. Then you have the $1071 to invest, minus the commissions.
Let's say for arguments sake you triple the 1071 over the 20 months.
$3213 is around a 20% profit over 20 months.
If AAPL goes to $193 over the 20 months it's a break even.
If the price of AAPL goes up you get none of the gains because your going to be exercised.
If the price goes down you lose on the stock, but may gain on the option if you buy it back.
If the stock stays flat you break even on the stock but gain on the option due to time decay if you buy it back.

I'd say there are better ways to play this.

[netwrangler]

Aiki is right that you can't write two 'covered' call options on the same shares. That's what bothered me about the 'strategy'.

Since the 'strategy' says:
Then you take the $8000 premiums to do shorter term covered calls for may/june.
maybe the shorter term calls aren't 'covered' calls at all. Maybe the idea is to use the proceeds from the leap to buy shorter term calls and play the volatility at various times throughout the year.

That works great if you can be sure to buy the shorter term calls in months when AAPL is going to go up. Of course, if you know when those months are, there are lots of ways to make money. :D

I, too, am bothered about tying up your investment for 9 months with the leap. It isn't clear to me what the leap is giving you. You could finance the shorter term calls just as well by buying fewer shares of AAPL — oh, unless 100 shares is all you have funds for. Even so, the 'strategy' seems a little forced.

Another approach is to buy the shares and sell short-term covered calls against the shares throughout the year. Since I am a covered call investor, you might expect me to favor that approach. However I am not really comfortable using it with AAPL. Too much volatility makes covered calls really dicey to manage.

Overall I agree with Aiki. There are better ways to play this than the 'strategy' suggested by your friend.

[Shhhhh]

Thank you both for your replies. Aiki, I completely agree with you with regards to tying up the money for so long., its seems like a ton of risk to me with not so much reward.

Netwrangler... I too like doing shorter term covered calls. I'm by no means an expert I like doing in the money calls that can still provide 5+% gain within a few months time. I have a couple I'm looking at for june/july expiry:
SIRO June 25s
BKS July 30s
BWLDJune 22.5s

Anyway I'd be interested in what stocks you look for and how you play writing CCs

Thanks to all; now I have some fodder to go back to arguing with my friend!!

[wallstreetsedge]

what you could do is create a spread by buying a deep itm call going out to say 2010 and sell atm or otm calls spot month every month.. you can normally generate some nice profits taht way with less capital