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Saturday, November 17, 2012

Born To Sell Article About Time Premium

Here is an article sent to Sell The Call by Born To Sell. It was back in September.

A Lot Of Time Premium
Ever wonder how much total time premium is in the market at any given time?
It turns out that right now there are 130,513,596 open call option contracts. The sum of all the time premium in those 130 million contracts is $18,757,615,007.42. That's $18 billion of wasting assets that someone is going to collect (*)!
billion dollarsWhat does $18B look like?
We couldn't find a photo of $18 billion in cash (and, sadly, are a wee bit shy of the $18B needed to take our own photo), but we did find a photo of one billion in cash. You'll just have to imagine 18 times as much as the pile of $100 bills pictured here.
And if you want to see a LOT of cash (like 1000 times as much), check out theTrillion Dollars article from January.
(*) Since 60% of contracts are closed prior to expiration, only 40% of $18B, or roughly $7B is going to time decay to zero between now and expiration. Of course, some contracts will partially decay before being closed, and new contracts will be opened between today and expiration, so it is likely more than $7B of premium will be collected. In any case, it's a big number and you should get your piece by selling some premium!
Five Ways To Increase Portfolio Income
There are many ways to use covered calls to increase your portfolio's income. Here are five of them:
  1. Turn non-dividend stocks into yield generators. Any stock in an existing portfolio can generate a dividend-like yield by selling out of the money call options. Probably want to sell 10% out of the money strikes so you leave yourself some upside potential on the underlying stock or ETF (it is presumed you are bullish, since you already own them).
  2. Double Dividends. If your stock pays 3%/year, why not make it pay 6%? Take the annual dividend and divide by 12. That's the amount of time premium you need to capture each month in order to double the yield. Example: If your stock pays $1.20/year dividend, sell out of the money calls to generate 10 cents/month ($1.20 / 12) or more in premium (probably a bit more to cover transaction costs). If you don't like the near month strike price that is offering 10 cents of premium, then go out 3 or 6 months and try to get 30 or 60 cents of premium at a strike you are happy with. The point is, premium should average 10 cents per month (after transaction costs) in order to double your dividend (for this example stock).
  3. Target Yield. Say you have a goal of 1%/month in income (12%/year). All you have to do is find the deepest in the money buy-writes that yield 12% or more on an annualized basis (including dividends, since your goal is simply to have 1%/month in overall yield). Once you have those buy-writes identified, sort by downside protection, eliminate risky situations (like earnings before expiration, small market cap, thinly traded, biotech, etc) and then research the ones at the top of the list. (hint: our screener will save you a ton of time)
  4. Dividend Capture. Find all stocks that have an ex-dividend date before the option expiration date. Remove those with earnings before expiration and then sell in the money calls. You'll get time premium plus the dividend. If the time premium remaining the day before the ex-dividend date is really small (zero or very close to zero) then you may getearly exercised, but you'll still make something. (hint: our screener has a special dividend search to help you with this strategy)
  5. Time Premium Capture. Sort all 240,000 covered calls by annualized return and then downside protection, research the ones at the top of the list, and then do some deep in the money short-term buy-writes to capture time premium. (hint: not surprising, our screener does this for you)
Any way you do it, you can increase portfolio income and lower portfolio volatility by selling calls on stocks and ETFs you own (or buying stocks just for that purpose).
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