assets in foreign markets is one method of accomplishing that goal.
Overall, I lost just over $500 this month, or about one-half of 1 percent.I’m not happy, but I did outperform the market by a wide margin, so havenothing to complain about. For the first three months of the year my prof-its are just over 1.5 percent. I had hoped to do much better, but it’s not easyto make money from bullish positions with the market down 2 percent forthe year.
TABLE 15.3A April Expiration Trades
B/S/W
Qty
SYM
Price
Call
Prem
Comm
Invested
BW
BW
BW
6006
2002
1001
VTIVTI
MDYMDY
EFAEFA
109.89
111.05
136.20
Apr 110
2.30
Apr 111
2.05
Apr 136
2.25
10.0019.00
10.0013.00
10.0011.50
Invested
Cash StartCash Now
($65,944.00)$1,361.00
($22,220.00)$397.00
($13,630.00)$213.50
($99,822.50)
$102,041.00$2,218.50
4339_PART4.qxd  11/17/04  12:57 PM  Page 153
nruteR
%612
.
%461
.
%221
.
%291
.
tcetorP
nwoD
%502
.
%471
.
%941
.
.
007931$
,
.
00753$
.
05361$
.
057191$
,
.
46701
.
21901
.
71431
.
)0032812$(
,
.
)0561431$(
,
.
058122$
,
.
)0522899$(
,
.
00140201$
,
.
05859301$
,
.
00793$
.
05312$
.
)0038546$(
,
.
001631$
,
011rpA
111rpA
631rpA
detsevnI
tnuoccA
eulaV
latoT
hsaC
latoT
XAM
.
98901
.
50111
.
02631
tiforP
laitnetoP
-
nevEkaerB
detsevnI
elaS
tpO
llaC
ecirP
ytQ
006
002
001
YDM
AFE
I
TV
FTE
153
snoitisoP
noitaripxE
lirpA
.
B351ELBAT
       4339_PART4.qxd  11/17/04  12:57 PM  Page 154
L/P%
%370–
.
%190–
.
%221
.
.
)00374(
.
)00991(
.
05361
L/P
%150–
.
.
)05805(
sdeecorP
elaS
tnerruC
eulaV
tsoC
tnerruC
noitisoP
dengissA
ecirP
ecirP
FTE
gnidnE
gninepO
stluseRnoitaripxE
lirpA
.
C351ELBAT
154
.
0008531$
,
.
0001146$
,
.
0042612$
,
.
)0038546$(
,
.
)0032812$(
,
.
)0561431$(
,
.
0008531$
,
.
0043758$
,
.
)0522899$(
,
.
058122$
,
.
0589751$
,
.
00140201$
,
.
05235101$
,
006
002
0
oN
oN
seY
latoT
tratS
dnE
hsaC
hsaC
.
58601
.
21801
.
71931
.
98901
.
50111
.
02631
YDM
AFE
I
TV
eulaVtnuoccAgnidnE
eulaVtnuoccAgninnigeB
        4339_PART4.qxd  11/17/04  12:57 PM  Page 155
Covered Call Writing In Action
155
MAY EXPIRATION
Over the weekend I considered my investment program and my portfolioand decided to maintain my positions. I plan to repurchase the 100 sharesof EFA I was forced to sell.
On Monday morning things are looking better. There were a few goodearnings  surprises  this  morning—companies’  quarterly  earnings  reportswere better than analysts expected—and the futures predict a higher open-ing  for  the  market.  I  got  a  bit  lucky  this  time:  My  holdings  increased  invalue since last Friday’s closing prices. That gives me the chance to earn abit more money this month, but of course the results depend on where themarket is when expiration arrives in four weeks.8My trades are summarized in Table 15.4A.I maintained my overall style by writing VTI and MDY options as closeto the money as possible. However, I decided to take a small chance andwrite the call that is 1 point out of the money for my EFA shares. The for-eign markets have been doing pretty well lately, and I thought I’d attempt tomake a bit extra this time. My positions are summarized in Table 15.4B.
Note the total value of my account is higher than it was at the previousexpiration (Table 15.3C) because the market opened higher this morningand my VTI and MDY positions increased in value.
The market, ever full of surprises, did a complete about-face this monthand more than recovered its losses for the year. This was the month wherethe  more  bullish  investors  did  very  well.  I  can’t  complain,  however,  as  Imade the maximum possible from each of my covered call positions, or 1.74percent. The results of my May expiration trades are listed in Table 15.4C.
May was one of those months that tests investors’ ability to stick with acovered call writing program. Even though my investment portfolio easily
TABLE 15.4A May Expiration Trades
B/S/W
Qty
SYM
Price
Call
Prem
Comm
Invested
W
W
BW
VTIVTI
MDYMDY
EFAEFA
6
2
1001
107.25
109.01
139.20
May 107
2.25
19.00
$1,331.00
May 109
1.90
13.00
$367.00
May 140
1.60
10.0011.50
($13,930.00)$148.50
Total
Invested
Cash StartCash Now
($12,083.50)
$15,798.50$3,715.00
4339_PART4.qxd  11/17/04  12:57 PM  Page 156
nruteR
%481
.
%161
.
%441
.
%471
.
tcetorP
nwoD
%702
.
%861
.
%990
.
.
001611$
,
.
00543$
.
05891$
.
054071$
,
.
30501
.
81701
.
28731
.
005173$
,
.
)0553289$(
,
.
05059101$
,
.
00556301$
,
.
)0053412$(
,
.
)0518731$(
,
.
00763$
.
05841$
.
)0091036$(
,
.
001331$
,
701yaM
901yaM
041yaM
detsevnI
.
52701
.
10901
.
02931
latoT
hsaC
tnuoccA
latoT
eulaV
XAM
tiforP
laitnetoP
-
nevEkaerB
detsevnI
elaS
tpO
llaC
ecirP
ytQ
006
002
001
YDM
AFE
I
TV
FTE
snoitisoP
noitaripxE
yaM
.
B451ELBAT
156
       4339_PART4.qxd  11/17/04  12:57 PM  Page 157
L/P%
%481
.
%161
.
%441
.
%471
.
L/P
sdeecorP
elaS
tnerruC
eulaV
tsoC
tnerruC
noitisoP
dengissA
ecirP
ecirP
FTE
gnidnE
gninepO
stluseRnoitaripxE
yaM
.
C451ELBAT
.
001611$
,
.
0008146$
,
.
)0091036$(
,
.
00543$
.
05891$
.
0008712$
,
.
)0053412$(
,
.
0008931$
,
.
)0518731$(
,
.
054071$
,
.
0004999$
,
.
000$
.
)0553289$(
,
.
005173$
,
.
00556301$
,
.
05059101$
,
.
00556301$
,
0
0
0
seY
seY
seY
.
05111
.
81411
.
69241
latoT
tratS
dnE
hsaC
hsaC
eulaV
eulaV
tnuoccA
tnuoccA
gnidnE
gninnigeB
.
52701
.
10901
.
02931
YDM
AFE
I
TV
157
    4339_PART4.qxd  11/17/04  12:57 PM  Page 158
158
CREATE YOUR OWN HEDGE FUND
Why Covered Call Writing Is Wrong for Some Investors
If you own shares of an ETF (or individual stock) and write a covered call op-tion, how will you react if your investment starts to rally and you watch theprice rise steadily? If you are pleased to see the market rally and recognizethat a rising market allows you to earn the maximum profit this investmentmethod can produce, then covered call writing is suitable for you.
However, if you are going to tell yourself that writing the call was amistake and if you blindly fix that mistake by buying back the call you soldearlier (at a substantial loss), hoping the underlying ETF continues to in-crease in value, then covered call writing is not for you.
Of course, you can buy back the call written earlier when the underly-ing  is  rising  in  price.  Repurchasing  a  call  previously  sold  is  not  only  ac-ceptable, but can be part of an intelligent strategy that involves changingyour  position.  The  dangerous  part  arises  when  the  call  is  bought  out  offrustration at having sold it in the first place, with no follow-up plan of ac-tion. If your plan is to buy back the option and simply hold onto your ETFshares (unhedged) in an attempt to recover the loss resulting from the orig-inal option sale, then you are attempting to time the market, a most diffi-cult  undertaking.  Many  beginners  fall  into  this  trap  because  they  simplycannot tolerate seeing the option they sold increase in price. You may wishyou had waited before writing the call options, but it’s important to recog-nize  that  a  rising  market  is  good  for  you.  After  all,  you  are  a  bullish  in-vestor, you have a significant portion of your assets invested in the stockmarket, and a rising market allows you to earn decent profits. If you can’tget it out of your mind that you want to make a fortune in the market—andmake it immediately—then covered call writing, an investment methodol-ogy that requires some patience, is not for you. That’s OK, as not all in-vestment  methods  suit  every  investor.  Find  what  works  for  you,  bothfinancially and psychologically.
A prudent investor does not base investment methods on hoping for
the best.
Later we’ll take a closer look at how investors can buy back an optionsold earlier, when we examine how to roll a position to take advantage ofrising prices.
performed better than the overall market during the first few months thisyear, I could have made more money during May if I owned ETFs outrightand did not write covered call options. Of course, I recognize that underper-forming during the most bullish months represents one of the risks of adopt-ing this strategy and am willing to accept that occasional underperformance.I believe that over an extended period of time I’ll earn enough extra money to
4339_PART4.qxd  11/17/04  12:57 PM  Page 159
Covered Call Writing In Action
159
more than compensate for my reduced (compared with the averages) earn-ings during those strongly upward markets by outperforming those averagesunder other market conditions. (In reality, I’ll do very well when the marketis strongly bullish. But I’ll earn less than the investor who is unhedged.)
I’m very pleased with my May results. It’s a good feeling to make themaximum possible profit, but the rising market leaves me feeling uncom-fortable. I hope the market continues to rally, but I’m afraid of a decline. Myaccount  now  contains  all  cash  and  no  remaining  positions.  Of  course  I’llreinvest the entire amount next Monday, nervous about the future or not,and I’ll use the weekend to decide if I want to change my mix of investments.Note: A problem can arise for investors who cannot accept less than thebest possible results. Even though these investors may recognize covered callwriting performs well over time and represents a realistic method for out-performing the market averages, if they cannot do better than the averagesevery year, they are unhappy. As noted in Chapter 12, covered call writing re-turned smaller profits than the market averages during the most bullish yearsat the close of the twentieth century, when the technology bubble was grow-ing. Even with that several-year period of underperformance, over the historyof the BuyWrite index, covered call writing made more money than simplyowning the S&P 500 index. If you are one of those investors who must havethe best of all possible results every time, think twice about using coveredcall writing as a method of enhancing your returns.
JUNE EXPIRATION
The rally continues on Monday morning, and all the ETFs I want to buy areslightly  higher  than  last  Friday’s  closing  prices.  Again,  I’m  going  for  theextra profit on my overseas investments and am writing the 1-point OTMcall on my 100 shares of EFA.
I’ve decided to make a minor change in my investment portfolio. My
new portfolio consists of this mix of ETFs:
100 EFA
200 MDY
500 VTI
200 OEF (tracks the S&P 100 index)
I added OEF to my portfolio for three reasons:
1. It’s  a  broad-based  index  and  tracks  the  performance  of  100  large 
companies.
4339_PART4.qxd  11/17/04  12:57 PM  Page 160
160
CREATE YOUR OWN HEDGE FUND
2. Coupled with MDY, it allows concentration in market segments that ex-
clude the more volatile small-cap stocks.
3. It allows me to put virtually all my idle cash to work. I don’t want sev-eral thousand dollars sitting in my brokerage account uninvested.
My trades for the month are summarized in Table 15.5A.My positions and potential profits are listed in Table 15.5B.I bought my 500 VTI shares at a price of $111.65, making it difficult tochoose the appropriate strike price to sell. Maintaining my philosophy ofwriting the call that is closest to the money, I chose the Jun 112 call. Choos-ing the option to write for my other positions was much simpler.
June was a dreadful month for the market.After a day or two of higher prices, there was some political unrest inthe Middle East. Using that as an excuse, nervous traders sent the marketlower. Within two weeks the market was down over 4 percent, and expira-tion is still two weeks in the future. I decided it was time to protect my port-folio and to sacrifice some potential profits. The options I sold earlier aretrading at low prices (example: VTI Jun 112 call can be bought for $0.30).Thus, they provide very little downside protection. I am going to buy backthose calls and simultaneously write new calls with lower strike prices. Be-cause there is only a short time to the June expiration, I’m also going tomove  the  position  to  the  following  month  by  writing  calls  that  expire  inJuly. This process is called rolling down and out.
TABLE 15.5A June Expiration Trades
B/S/W
Qty
SYM
Price
Call
Prem
Comm
Invested
BW
BW
BW
BW
5005
2002
1001
2002
VTIVTI
MDYMDY
EFAEFA
OEFOEF
111.65
114.25
143.06
57.08
Jun 112
1.95
Jun 114
2.15
Jun 144
1.60
Jun 57
0.90
10.0017.50
10.0013.00
10.0011.50
10.0013.00
($55,835.00)$957.50
($22,860.00)$417.00
($14,316.00)$148.50
($11,426.00)$167.00
Total Invested
($102,747.00)
Cash StartCash Now
$103,655.00$908.00
4339_PART4.qxd  11/17/04  12:57 PM  Page 161
nruteR
%102
.
%051
.
%051
.
%701
.
%371
.
tcetorP
nwoD
%071
.
%871
.
%790
.
%831
.
.
052011$
,
.
00733$
.
05212$
.
00121$
.
003771$
,
.
67901
.
22211
.
86141
0365
.
.
)0577845$(
,
.
)0034422$(
,
.
)0576141$(
,
.
)0095211$(
,
.
05609
.
05356301
,
.
05624501
,
.
)00747201$(
,
.
05759$
.
00714$
.
05841$
.
00761$
211nuJ
411nuJ
441nuJ
75nuJ
.
56111
.
52411
.
60341
8075
.
hsaC
detsevnI
latoT
tnuoccA
latoT
eulaV
XAM
tiforP
laitnetoP
-
nevEkaerB
detsevnI
elaS
tpO
llaC
ecirP
ytQ
005
002
001
002
YDM
I
TV
AFE
FEO
FTE
161
snoitisoP
noitaripxE
enuJ
.
B551ELBAT
        4339_PART4.qxd  11/17/04  12:57 PM  Page 162
162
CREATE YOUR OWN HEDGE FUND
Rolling a Position Type I. Rolling for Protection
The term “rolling” refers to moving a position from one option to another.The term is used when the new option has a different strike price, a differ-ent expiration month, or when both are changed. When rolling a position,there are many choices. The recommended method for choosing the newoption to write is to pretend you are opening a new position. Write the op-tion that meets your criteria for profit potential and protection.
Two trades are required to roll a position: (1) repurchase the optionsold earlier, then (2) immediately (to avoid remaining unhedged) write anew call option. The newly sold call has a lower strike price and expires ina later month. For example, with VTI trading at $107.50, I bought 5 VTI Jun112  calls,  paying  $0.30  for  each,  and  sold  5  VTI  Jul  108  calls,  collecting$3.05. Table 15.5C shows the trades made to roll each position.
Note: When rolling, I can call my broker and enter a spread order. Suchan order consists of (at least) two separate trades that are tied together,with the condition that both portions of the order must be filled or neitherportion is to be filled.
Example: I could call my broker and say: “Buy 5 VTI Jun 112 callsand sell 5 VTI Jul 108 calls for a net credit of $2.75 or better.” Thismeans that I want to collect at least $275 (five times) when makingthese two trades. If the broker is unable to make both trades at pricesthat meet my conditions, then no trades are made. That leaves mewith my original position.
Note: It’s not necessary to call your broker if you trade online. Simply
buy the previously sold option and quickly sell the new option.
TABLE 15.5C June Expiration: Trades to Roll Positions
ETF
Qty
CurrentPrice
BoughtCalls
VTIMDYEFAOEF
5212
107.50109.90141.7554.99
Jun 112Jun114Jun 144Jun 57
BuyPrice
0.300.150.550.05
SoldCalls
SellPrice
SpreadCredit
CashCollected
Jul 108Jul 110Jul 142Jul 55
$2.753.05$2.552.70$1.502.050.80$0.75Cost to RollOld CashNew Cash
$1,340.00$484.00$127.00$124.00$2,075.00$906.50$2,981.50
Cash Collected: After commissions ($10 per trade + $1.50 per contract)
Cost to Roll: The amount is positive because I collected cash to make the trades
4339_PART4.qxd  11/17/04  12:57 PM  Page 163
Covered Call Writing In Action
163
Because I’m anxious to make the trade and reduce the chances of mysustaining further losses, I chose to trade online without taking the time totelephone the order to my broker. Besides, if I try to place this limit orderthrough a broker, there is always the chance the order will go unfilled.9 Iam unwilling to use a market order, so I quickly make the trades by myselfonline.10
My new positions are listed in Table 15.5D.There are several points of interest in these trades:
• By writing a call with a lower strike price, I collect additional optionpremium.  This  extra  cash  provides  additional  protection  in  case  themarket heads even lower.
• By writing calls with a lower strike price, I’m giving up my chance toearn a decent profit this month. My best possible result this month is aprofit of only $446. Still, I’d be thrilled to do that well, considering howfar the market has declined in these past two weeks.
• I have one position (OEF) that is not only under water (losing money),but there is no chance it can make any money. Note in Table 15.5D thatmy best result for OEF is a loss of $155. And I’ll do that well only if OEFis above the strike price when expiration arrives in six weeks.
• It’s far more important for more conservative investors to preserve cap-ital than to worry about making a profit every month. More bullish in-vestors might prefer to take their chances and not roll the position, butthat’s not a risk I am willing to take.Note: The BXM methodology never rolls a position.
• By writing July calls instead of June calls, I collect additional time pre-mium.11 This means that unless I want to roll to different strike prices,I may not have any trades to make when June expiration arrives, as I’vealready sold my July options.
• The premium I received for writing the VTI Jul 108 calls is higher thanmight have been expected. One reason for this is that declining markets(and  especially  rapidly  declining  markets)  tend  to  make  investorsafraid that a much larger price drop is possible. Thus, more people areeager to buy put options—either to hedge their portfolios or to profitfrom a market decline. This increase in the number of put buyers alsopushes call prices higher.12 The phenomenon of rising option prices isthe result of an increase in the implied volatility (IV) of the options.13
I feel more comfortable with my positions after rolling, but the marketcontinued its decline. When June expiration arrived, the S&P 500 was lowerby more than 6 percent for the month. Rolling saved me from incurring alarge loss, but I still lost money this month. The only good news that comesfrom this market decline is that fear has gripped some investors and option
4339_PART4.qxd  11/17/04  12:57 PM  Page 164
%540
.
.
00844$
nruteR
%380
.
%010
.
%990
.
%931–
.
tcetorP
nwoD
%040
.
%010
.
%590
.
enoN
laitnetoP
tiforP
.
0012$
.
05244$
.
05931$
.
)00551$(
-
nevEkaerB
.
80701
.
08901
.
14041
8655
.
.
)0095912$(
,
.
)0504041$(
,
.
)0053111$(
,
.
)00276001$(
,
.
05609$
.
005702$
,
.
051892$
,
.
05356301$
,
.
05101401$
,
.
00484$
.
00721$
.
00421$
.
)0573535$(
,
.
000431$
,
detsevnI
hsaC
woN
detcelloC
gnilloR
morFhsaC
detsevnI
hsaCdlO
hsaCweN
eulaV
eulaV
XAM
tnuoccA
801
011
241
55
l
uJ
l
uJ
l
uJ
l
uJ
weN
sllaC
tnerruC
ecirP
.
05701
.
09901
.
57141
9945
.
ytQ
FTE
5
2
1
2
YDM
I
TV
AFE
FEO
gn
ill
oRretfa
snoitisoP
:noitaripxE
enuJ
.
D551ELBAT
164
ecirp
neve-kaerb
hcaer
ot
ecirptnerrucmorf
en
ilced
nac
FTE
tnuomA
:tcetorPnwoD
noitaripxe
ta
dengissa
fi
)htnomeritne
rof(
tiforpmumxaM
i
:laitnetoP
tiforP
htnomeritne
rof
tiforpmumxaM
i
:
nruteR
snoissimmoc
retfa
,ll
or
morf
detcell
oc
hsaC
:
detcellochsaC
sllac
nettir
wyl