Mastering Covered Calls (Option Alpha)

Letter from Kirk
Covered calls are the proverbial “bridge” which many traditional stock investors
cross into the world of options trading. The gateway or door to a new paradigm
of investing that, when used correctly, offers higher returns and less risk. Yet,
most investors are scared away before they even take the rst step
We are taught by traditional media, schooling, and decades of conditioning that

the only way to invest and build wealth is via stocks. That you cannot beat the
market so why try? But, what if that wasn’t actually true? Wouldn’t you have a
moral obligation to change the way you invest if we proved that you could beat
the market? We think so
The goal of is this book is to help educate you on how options trading, in
particular covered calls, can help transform the way you build wealth and invest
your hard-earned money. You see, options trading isn’t new; it just might be new
to you. All you need is someone to hold your hand and help you walk across the
bridge
There’s a completely new world waiting for you and I’d love to be your guide as
you start, or continue, this journey. Let’s get started…
.
fi
.
Reproduction and distribution of this report, in any form, partial or full, of its content herein via, including but not
limited to email, social media, download, hard-copy, screenshot, image, etc. is strictly prohibited without advanced and
express written consent by Option Alpha LLC. Any individual, company, and/or entity found in breach of this
agreement will be subject to all legal remedies available at law, including litigation.
Option Alpha™ is the copyright and trademark holder of all branded properties for Option Alpha, LLC and Alta5 Inc., and Kirk N. Du Plessis. Neither the Option Alpha, LLC
and Alta5, Inc., Kirk N. Du Plessis, or any of its af liates, owners, managers, employees, shareholders, of cers, directors, other personnel, representatives, agents or
independent contractors (herein referred to as the “Company”) is, in such capacities, a licensed nancial advisor, registered investment advisor, registered broker-dealer or
FINRA | SIPC | NFA-member rm. Examples presented on Company’s website including video tutorials, indicators, strategies, columns, articles, emails, reports,
downloads, and all other content of Company’s products (collectively, the “Information”) are provided for informational and educational purposes only. Such set-ups are not
solicitations of any kind or order to buy or sell a nancial security and should not be construed as investment advice under any circumstances.
The Company will not be held liable for losses resulting from information or advice presented in this information (or from a third party); the use of such information is
entirely at the risk of the user. The Company assumes no responsibility or liability for your trading and investment results whatsoever under any circumstances. The sole
and exclusive maximum liability to the Company for any damages or losses shall solely be dissatisfaction to the user. The risk of loss in trading securities, options, stocks,
futures and forex can be substantial. Securities involve risk and are not suitable for all investors. Consider all relevant risk factors, including your personal nancial
situation, before trading. Past results of any individual or trading system published by the Company are not indicative of future returns. It should not be assumed that the
methods, techniques, or indicators presented in these products and services will be pro table or that they will not result in losses. Backtesting provides a hypothetical
calculation of how a security or portfolio of securities, subject to a trading strategy, would have performed over a historical time period. You should not assume that
backtesting of a trading strategy will provide any indication of how your portfolio of securities, or a new portfolio of securities, might perform over time. You should choose
your own trading strategies based on your particular objectives and risk tolerances. Be sure to review your decisions periodically to make sure they are still consistent with
your goals. Past performance is no guarantee of future results that may be assumed from this report and its ndings.
YOU EXPRESSLY UNDERSTAND AND AGREE THAT THE COMPANY SHALL NOT BE LIABLE TO YOU FOR ANY DIRECT, INDIRECT, INCIDENTAL, SPECIAL,
CONSEQUENTIAL OR EXEMPLARY DAMAGES, INCLUDING BUT NOT LIMITED TO, DAMAGES FOR LOSS OF PROFITS, GOODWILL, USE, DATA OR OTHER
INTANGIBLE LOSSES (EVEN IF THE COMPANY HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES), RESULTING FROM: (I) THE USE OR THE
INABILITY TO USE THE SERVICE; (II) THE COST OF PROCUREMENT OF SUBSTITUTE GOODS AND SERVICES RESULTING FROM ANY GOODS, DATA,
INFORMATION OR SERVICES PURCHASED OR OBTAINED OR MESSAGES RECEIVED OR TRANSACTIONS ENTERED INTO THROUGH OR FROM THE
SERVICE; (III) UNAUTHORIZED ACCESS TO OR ALTERATION OF YOUR TRANSMISSIONS OR DATA; (IV) STATEMENTS OR CONDUCT OF ANY THIRD PARTY ON
THE SERVICE; OR (V) ANY OTHER MATTER RELATING TO THE SERVICE. SOME JURISDICTIONS DO NOT ALLOW THE EXCLUSION OF CERTAIN WARRANTIES
OR THE LIMITATION OR EXCLUSION OF LIABILITY FOR INCIDENTAL OR CONSEQUENTIAL DAMAGES. ACCORDINGLY, SOME OF THE ABOVE LIMITATIONS
MAY NOT APPLY TO YOU.
fi
fi
fi
fi
fi
fi
fi
fi
Table of Contents
1) Options Basics 5
2) Covered Calls 20
3) Strategy Setup 29
4) Position Management 43
5) Synthetic Strategies 52
Chapter One
Options Basics
stock. Option contracts include four additional elements; an
expiration date, strike price, option premiums, and are
Whether you're an experienced options trader or classi ed as either calls or puts
a newbie, it's easy to jump into this guide with
NOTE: We'll often refer to the stock shares as the underlying
both feet and dig right into the covered call stock or underlying shares. The term "underlying" is speci c
strategy to the world of options trading. It references the stock shares
that serve as the base, or basis, for the options contract,
If you're the latter, let's rst make sure you have a little which is created on top of the shares. Since options contracts
background info on options trading jargon, or you might derive their value from the stock shares, we use the word
quickly get confused. As such, we thought it would be good "underlying" to describe the logical hierarchy of the option
to go over a bunch of essential "options basics" together, contract. The option contract is built on top of the stock;
including options speci c terminology. If you're already an therefore, the stock shares are underlying to the option
experienced investor and familiar with options, feel free to contract
skip right ahead to Chapter 2. If not, then you'll enjoy the
newfound jargon, which is unique to options trading Expiration Date
In either case, it's always good to go through the basics and Options expiration is the date when the option contract for
make sure you understand the foundational elements before the underlying stock expires or is terminated. It's the point at
moving forward. So, try not to skip this section. Please take which the option buyer ultimately has to decide to convert, or
the time now to develop, or refresh, your basic options what is commonly referred to as "exercise," their option
trading knowledge contract into shares of stock. Most optionable stocks have a
wide variety of expiration dates. These include weekly
Options Contract expirations, monthly expirations, and quarterly expirations
An options contract is simply an agreement between two For example, you might enter into a contract that expires in
parties for the sale or purchase of an underlying stock at a 30 days or 90 days from today. As the name suggests, the
pre-determined price in the future. Each option trade requires expiration date for options contracts can vary in the future so
an option seller and an option buyer. Typically, one option that both option buyers and sellers can appropriately match
contract controls or leverages 100 shares of the underlying their desired timeline and exposure. As a general rule, the
Chapter One Option Alpha © 2019. All Rights Reserved. 6 of 65

fi
.
fi
fi
.
fi
.
further out in time the expiration date is, the more valuable are trading, whether call options or put options, which are
the option contract compared to a shorter expiration date discussed next. Option prices are quoted in dollars per share
contracts for simplicity, but more often, this creates a little confusion for
traders
Strike Price
For example, you might see an option contract price quoted
In any option contract, the two parties (option buyer and the as $1.45 on your broker platform. This means that the
option seller) need to agree on the price at which they are contract's value is $1.45 for each share, and since the
mutually comfortable, either buying or selling stock in the standard contract multiplier is for one contract is to leverage
future. This future price is called the strike price. It is called or control 100 shares, the actual real value of the contract in
this because it is the price at which they "strike a deal" on total dollars is $145. Likewise, an option contract quoted at
agreeing to exchange underlying shares regardless of the $0.37 is worth $37 total dollars and an option contract quoted
market value of the shares at the time of expiration. The at $4.78 is worth $478 total dollars. Option premiums change
strike price can vary greatly and range in prices below or frequently and are determined by two main factors; intrinsic
above the current underlying stock price value and extrinsic value, which we'll cover in more detail in
For example, let's assume that shares of stock for a an upcoming section
company are trading at $95 per share. You could trade an Call & Put Options
option contract with a strike price of $105, effectively $10
above the current market price, or with a strike price of $80, There are only two classi cations, or types, of options
effectively $15 below the current market price. Strikes prices contracts; call options and put options. Since you can choose
can have increments as low as $0.50 to as wide as $50 to be either an option buyer or seller of calls and puts, we
want to rst walk through the rights and obligations of each
Option Premiums scenario. As a general rule, buyers of options have rights,
As you might expect, there's no free lunch when trading and sellers have obligations. Keep this quick rule in mind as
options and all option contracts require a premium to be paid we move forward
by the option buyer to the option seller to complete the Call options give the option buyer the right, but not the
transaction. The buyer always pays the premium, and the obligation, to purchase the stock at the strike price at
seller always receives it no matter what type of option you expiration. And because the choice to buy stock, or not, in

.
fi
.
fi
.
the future is valuable, call option buyers pay an option As a reminder from a couple paragraphs back, option buyers
premium in exchange for this right to choose. Alternatively, have the right, but not the obligation, to exercise (convert) the
the premium paid by the option buyer goes to the call option option contract into underlying stock. Therefore, the option
seller, which now has an obligation to sell the stock at the buyer is always the one who could exercise their contract,
strike price at expiration, or before, if the option buyer and the option seller is always the one who gets assigned an
exercises or enforces their contract options contract. It's as simple as that. Buyers exercise,
sellers are assigned
Put options give the option buyer the right, but not the
obligation, to sell the stock at the strike price at expiration. The question you should be asking at this point is, "When
Just like call options, this choice to sell the stock, or not, in would an option buyer exercise their contract?" The option
the future is valuable. Therefore, put option buyers pay an buyer would only choose to exercise their contract and buy/
option premium in exchange for this right to choose. The sell shares at the strike price if it's nancially pro table for
premium paid by the option buyer goes to the put option them to do so before or at expiration. Again, pretty simple
seller, which now has an obligation to buy the stock at the when you think about it logically
strike price at expiration, or before, if the option buyer
exercises or enforces their contract If exercising their contract would create a larger loss than the
value of the option premium paid to enter into the agreement,
then the option buyer would simply let their contract expire
worthless. In this case, the option seller would keep the
Exercise & Assignment entire premium collected at the beginning of the transaction
Now that we've covered the four main elements of an options as a pro t
contract lets quickly discuss the logistics of how exercise and Option Contract Examples
assignment work. Exercise and assignment are the
processes by which options contracts are converted to Alright, we've hit you over the head with enough terminology
underlying shares. Oddly enough, it's effectively the same and de nitions for now. If things are getting a little fuzzy and
transaction happening but commonly called two different blurred, we're going to bring all of these concepts together
names depending on which side of the contract you are on with a few examples. In each example, we'll highlight the
initially; buyer or seller option contract details and walk through the speci cs of what

fi
fi
.
fi
.
fi
fi
might happen at expiration for different stock price scenarios. math analysis shows that it would be nancially unwise to do
Let’s dive in so
Example #1: Call Option If you were to exercise your call option, you would purchase
the stock at $57 per share (strike price) when it's only worth
Here's the setup for this option contract: $43 per share in the open market. Not a smart investment, so
1. Underlying stock is trading at $50 per share your best choice is to simply let the option contract expire
and lose the $3 premium you paid to the option seller. Losing
2. You purchase a call option contract $3 is better than losing $17 per share, the $3 premium paid
to the option seller plus the negative value of $14 from
3. The expiration date is 60 days from today
potentially buying shares at $57 when they are only worth
4. The strike price for your option contract is $57 $43
5. You pay an option premium of $3 It should be noticeable at this point that call option buyers
want the stock to rise signi cantly in value in the future. But
As a call option buyer, you now have the right, but not the how far does the stock need to rise to make it worth it for the
obligation to purchase the stock for $57 per share anytime in call option buyer to convert the option and exercise the
the next 60 days. After 60 days, your contract expires, and contract? Let's look at another scenario
you no longer have this right. The call option seller, on the
other side of the trade from you, has an obligation to sell Call Scenario 2: Stock closes @ $57 per shar
shares to you at $57 if you choose to exercise your contract.
The stock rose dramatically in value, and right to your strike
Let's walk through a couple of different expiration scenarios
price of $57, which is what you might have expected as a call
together. Remember that as the option buyer, you’re in
option buyer. Kudos to you for picking the right direction. But,
control of the choice to exercise the contract or not
unfortunately, the stock didn't move far enough as you would
Call Scenario 1: Stock closes @ $43 per shar also not exercise your call option contract in this scenario
and simply let it expire worthless. "But wait, Kirk, the stock
At expiration, it seems the stock moved lower from $50 to moved exactly where I wanted right?" Yes and no
$43. In this scenario, the best decision would be not to
exercise your call option contract. Why? Well, some simple

.
fi
.
fi
.
Recall that you paid an option premium of $3 to the call As always, the math works, or it doesn't, and in this scenario,
option seller to enter into this option trade. This option it is nancially pro table to exercise your call option
premium is a cost of doing business and cannot be swept
under the rug. We need to account for it somewhere. So, Even after paying the $3 premium to the call option seller 60
what we do in a call option scenario is add the option days ago and purchasing the stock at the strike price of $57,
premium to the strike price of the contract to get your you could sell the shares immediately in the open market for
effective “all-in-cost" of stock ownership. In our working $65 per share resulting in a $5 pro t per share overall. The
example, this break-even or “all-in-cost" is $60 per share; the call option seller, in this case, would be obligated to purchase
$57 strike price plus $3 option premium paid shares in the open market for $65, if they didn't own them
already, and sell them back to you at $57 (strike price) for an
With the stock trading at $57, there's no nancial bene t to $8 net loss per share on the stock. Don’t forget however, they
exercising the contract as you could just as easily purchase collected an upfront premium of $3 from you, the option
shares in the open market for the same price. Therefore, buyer, which reduces their overall net loss to just $5 per
your best decision is again just to let the call option expire share
worthless. The option seller would still keep the entire $3
premium as pro t at expiration As you might expect having coming this far in the scenarios,
purchasing call options requires both a signi cant move in
In this scenario, we've learned a vital new piece of the underlying stock and in the right direction to be pro table.
information. That the actual expected price for the stock or Both of which are hard to predict or estimate consistently for
break-even point, to make it pro table overall for the call the option buyer. What about put options though
option buyer, needs to be at a price per share that is above
the strike price plus the value of the option premium paid Example #2: Put Option
Call Scenario 3: Stock closes @ $65 per shar Here's the setup for this option contract:
Congratulations, the stock made a huge move, much higher 1. Underlying stock is trading at $50 per share
and well above your call option break-even point of $60 we 2. You purchase a put option contract
just calculated in the last scenario. At expiration, the best
decision would now be to exercise your call option contact. 3. The expiration date is 30 days from today

fi
.
fi
fi
.
fi
fi
.
fi
.
fi
.
fi
fi
.
4. The strike price for your option contract is $45 successfully, your pro t is the difference between where you
sold shares and where you purchased shares
5. You pay an option premium to the seller of $2
Put Scenario 1: Stock closes @ $52 per shar
As a put option buyer this time, you now have the right, but
not the obligation to sell the stock for $45 per share anytime The stock went up before expiration, but now that you are a
in the next 30 days. After 30 days, your contract expires, and put option buyer, this is terrible news for you. At expiration
you no longer have this right. The put option seller has an you would choose not to exercise your put option contract.
obligation to buy shares from you at $45 if you choose to Why? Well, if you were to exercise your put option, you
exercise your contract would sell shares of stock at $45, the strike price, but would
have to buy shares at the prevailing market price of $52 to
But why would you want to sell the stock when you don't complete the trading loop
even own it in the rst place? What nancial bene t is there
in this type of trade for you? The concept seems If in this scenario, we are selling shares at $45 and being
counterintuitive, but it's not. You see, most investors are used forced to buy them in the open market at $52, it's not a smart
to a single avenue for generating pro ts. They buy the stock investment decision. Your best choice is to simply let the put
at a low price and look to sell back the stock later on at a option contract expire and lose the $2 premium you paid to
higher price. Buy low, sell high the option seller. Losing $2 is better than losing $9, the $2
premium paid to the option seller plus the negative value of
Few investors realize, however, that you can use these same $7 from potentially buying shares at $52, and selling them for
buy and sell orders just in reverse to pro t from a stock $45
moving lower. When you reverse the order of buying and
selling, its called "shorting a stock," and you pro t from a Notice how these put options are starting to behave just like
decline in the underlying share price. Sell high, buy low the call option scenarios, only in reverse? Put option buyers
want the stock to fall in value in the future, similar to the
It works like this. You borrow stock from your broker to sell to expectations of someone shorting the stock. I'm sure you can
someone else in the open market. You're betting on the stock see where this is going based on the prior option examples,
moving lower and hope to purchase shares at a lower price but let's walk through some more scenarios just in case it's
later on to ful ll the trading loop and deliver the shares back not 100% clear
to the broker that you borrowed. When you do this

.
fi
.
fi
fi
.
fi
fi
fi
.
fi
.
fi
.
Put Scenario 2: Stock closes @ $45 per shar option. Even after paying the $2 premium to the put option
seller and purchasing stock in the open market for $40, you
The stock fell in value, as you might have expected, but still could sell the shares immediately back to the put option
not far enough to reach your break-even point. At $45, there seller at the strike price of $45 per share resulting in a $3
is no nancial bene t exercising your put option contract with pro t per share overall
the option seller. You could just as quickly buy shares at $45
in the open market and sell them back to the put option seller The put option seller, in this scenario, would be obligated to
for $45, which is essentially a wash buy shares at the strike price of $45 from you, when they are
valued in the open market at $40 per share for a net loss on
Recall that you also paid an option premium of $2 to the put the shares of $5 per share. However, they collected an
option seller. When we subtract this from the strike price, upfront premium of $2 from you, the option buyer, which
your effective break-even target for the stock is $43, the $45 reduces their overall net loss to just $3
strike price minus $2 option premium paid. So, the best
choice again is to let the put option expire worthless and lose As we witnessed with the rst call option example,
the entire $2 premium paid to the put option seller purchasing put options requires both a signi cant move in the
underlying stock and the right direction. It's tough to predict
For put options, we've now learned that in order for you to or estimate consistently how far a stock will drop and in what
make money as an option buyer, you need the stock to trade timeframe. There has to be a better way right? There is, and
low enough so that selling the stock at $45 creates a net we'll get there soon
pro t after paying the option premium. This expected price
for the stock or break-even point is calculated as the strike Reversing Trades
price minus the value of the option premium paid, $43 in our
example We've talked a lot so far about buying and selling shares at
expiration with options contracts. However, you should
Put Scenario 3: Stock closes @ $40 per shar understand that exercise and assignment of physical shares,
as described in the pages above, are rare. The reality is that
The stock closed well below your put option break-even point most options contracts are closed well before expiration by
of $43. Things are not looking good for the stock, and it's merely reversing the initial trade. Doing so doesn't impact the
falling hard, but as a put option buyer, this is excellent news outcomes or change the decisions you make, but rather
for you. At expiration, you would choose to exercise your put

fi
fi
fi
.
fi
.
fi
.
fi
e
opens up the possibility to exit or adjust positions before Intrinsic Value

expiration if you deem necessary.
Earlier in the description of option premiums, we mentioned
For example, let's assume you purchased an options that there are two main factors by which we determine an
contract, call or put, with 30 days until expiration. You don't option's value. These are broadly categorized as intrinsic
have to hold it until expiration unless you choose to do so. value and extrinsic value. We'll cover each of these in detail
You could choose to quickly reverse your trade and sell the in the following section
contract to someone else, which closes your position.
Likewise, if you sold an option contract to an option buyer, Intrinsic value is the current and immediate value of the
again call or put, you could buy back the contract from option contract for any strike price, which is currently in-the-
someone else and close the position, thereby removing your money (ITM). Said another way; it's the value or pro t should
obligation to deal with the stock at expiration the option buyer exercise their contract immediately. Call
options are said to be ITM when the strike price is below the
Statistically speaking, at Option Alpha we've only ever had to current stock price. Put options are said to be ITM when the
deal with the assignment of physical stock less than 1% of strike price is above the current stock price
the time in the last 10+ years of trading options. It's
something manageable and won't ever harm you so long as For example, if a stock is currently trading at $100 per share,
you are controlling your position size. We will explore this a call option with a strike price of $99 would have $1 of
topic in more detail during a later chapter, but be aware that it intrinsic value. If the call option were exercised right away,
is not an automatic assumption of exercise and assignment, the option buyer would be able to purchase shares at $99
and people worry about it way more than is necessary and sell them in the open market for $100. Likewise, a call
option with a strike price of $95 would have $5 of intrinsic
In the end, we hope that the examples we just went through value
added a lot more clarity to the relationship between option
buyers and sellers and how or when options contracts could On the put option side, the concept is the same, just in
increase or lose value at expiration. In the next sections, we'll reverse. A put option with a strike price of $101 would have
dig much deeper into the factors and inputs on how option $1 of intrinsic value as the put buyer could sell shares at
premiums derive their value. The goal is for you to $101 and repurchase them in the open market for $100.
understand how different market environments or situations Likewise, a put option with a strike price of $105 would have
impact an option contract's premium or price $5 of intrinsic value. Simple enough, right? Great

.
fi
.
Now, any strike price that is out-of-the-money (OTM), on the future time value of the contract based on the days remaining
other hand, would never have intrinsic value. Exercising the from now until expiration and the implied, or expected,
option contact when OTM would offer no immediate value to volatility in the stock. We'll cover each one of these time and
the option buyer. Call options are said to be OTM when the volatility components individually in the paragraphs below.
strike price is above the current stock price. Put options are For now, however, let's review a high-level options pricing
said to be OTM when the strike price is below the current example to reinforce the general concepts of intrinsic vs.
stock price extrinsic value components
For example, using the same stock currently trading at $100 Let's assume that our same stock from before is still currently
per share from above, a call option with a strike price of $101 trading at $105 per share. A call option contract with a strike
would be considered OTM and have no intrinsic value. The price of $100 and expiration date 30 days from now is
option buyer would never willingly choose to purchase shares quoting an option premium of $6.50 per contract. Can you
at a $101 strike price when they could easily buy shares in gure out how much of the value is associated with intrinsic
the open market for $100 per share. Likewise, on the put value vs. extrinsic value? Take your time and think about it
side, if a put option buyer owned an OTM contract with a for a minute
strike price of $99, they would never willingly choose to sell
shares at $99 when they would quickly sell shares in the Recall that an option's price is comprised of both intrinsic and
open market for $100 per share extrinsic value. So to answer our question, its best rst to
strip out the intrinsic value which is the easiest to calculate.
It should be clear by now that the intrinsic value portion of an The remaining portion is then merely the extrinsic value. The
option contract's premium is relatively easy to calculate and intrinsic value of the contract in our example would be $5, as
understand. The second part of an option contract's this is the value of the ITM contract if the contract was
premium, extrinsic value, is a little more complicated. Yet, it's exercised today. The extrinsic value would be the remaining
one of the most important aspects of option pricing you need $1.50 ($6.50 minus the intrinsic value of $5), which is
to understand attributed to the value of time and volatility over the next 30
days
Extrinsic Value
Now, take the same stock currently trading at $105 per
There's no easy way to dissect this pricing component, so share, and let's now look at a put option contract with a strike
we'll just tackle this head-on. Extrinsic value represents the price of $93 and expiration date 60 days from now, which is

fi
.
fi
quoting a price of $0.60 per contract. Little harder right? Not Time decay for option contracts moves at a progressively
really if you slowly walk through it. Here the put option faster pace as a contract nears its expiration date. Option
contract has no intrinsic value as the $93 strike price is OTM, contracts further from expiration will be worth more money,
and the put option buyer wouldn't pro t from exercising their all things being equal, compared to contracts closer to their
contract. If no value is associated with intrinsic value, then expiration date. These further out contracts will experience
the remaining amount is purely comprised of extrinsic value minimal impact on their price each day due to the erosion of
attributed to the time and volatility until expiration time decay. The nearer the contract gets to the expiration
date, the larger and more signi cant the impact time decay
In the next section, we'll unpack the time and volatility will have on the contract
components of extrinsic value as we continue to dive deeper
into what impacts an option's price. Then, we'll walk through Time decay of an option contract speeds up so quickly that at
the Option Greeks, which help us understand how an expiration, all that is left of the contract's value is simply the
option's price might change based on various market forces intrinsic value, if any. This is why time decay is so crucial for
options traders because it creates a constant battle between
Time Decay time and price. If the underlying stock price fails to move far
The rst sub-component of extrinsic value for an options enough or fast enough, then the option contract slowly
contract is time decay. All options contracts have a nite time decays under the weight of time decay
until expiration, which can be a few weeks or up to a few Implied Volatility
years from the current date. You will often hear traders
talking about 30, 60, or 90 days to expiration, and this refers The second and most important sub-component of an option
to the amount of time before the contract expires contract's extrinsic value is implied volatility. Admittedly,
implied volatility is the edge by which option sellers, and
As option contracts, both calls and puts, move nearer to their covered call writers, as you'll learn, gain a signi cant
expiration date, there is less time for them to move into a advantage in the market trading. Implied volatility is the future
pro table zone before they potentially expire worthless. expectation of how far a stock will move up or down by
Hence, all contracts slowly see their extrinsic value erode expiration. Since options have expiration dates in the future
through the passage of time as they draw closer to and strike prices higher or lower than the current market
expiration. This erosion in value is called time decay price for the underlying shares, it's critical that an option's
premium factor in the magnitude expectation of the stock's

fi
fi
.
fi
fi
.
fi
.
fi
.
price moving forward into the future. In the most basic terms, number due to how aggressively or not, they purchase call
if implied volatility is high, the stock is expected to swing and put options. This is why it's referred to as implied
wildly in the future. If implied volatility is low, the stock is volatility because the value is "implied" by the actions of the
expected to swing very little and mostly stay range-bound or market participants as a whole
move sideways
So, what if the expectations for future stock volatility change?
Generally speaking, implied volatility impacts the premium of What if implied volatility goes up to 12% from 10%?
options contracts the same for both calls and puts. When Whatever the catalyst, market participants expect the stock
implied volatility increases, or more simply the expectation of to be more volatile in the future. And as a result, start more
future stock volatility increases, it causes an increase in the aggressively purchasing call options at higher prices. The call
value of both calls and puts. When implied volatility option contract might then adjust up in value from $6.50 to
decreases, or the expectation of future stock volatility $7.50 per contract. Notice that the only change here is the
decreases, it causes the value of both calls and puts to go future expectation of volatility. The underlying stock price nor
down the time until expiration was changed, so you can see just
how much of an impact implied volatility has on option pricing
Using the same example we've referenced throughout, let's as a single component
assume a stock is currently trading for $100 per share. A
$105 strike call option is quoted at $6.50 per contract. We Option buyers might be willing to pay more money for the
might also see on the option pricing table that the stock is options contract if they think a more signi cant move is
showing 10% implied volatility. This means market coming in the future. Whether that move comes or not is
participants expect the stock to move up or down 10% another discussion altogether, which we'll cover later on. The
between now and expiration. This doesn't mean it can't move key concept, for now, is that traders and investors bid up and
more or less; it obviously could. It just means that the down an option's price in relation to how far they believe or
expectation right now, based on all information available and expect a stock to move in the future
the actions of market participants, is that the stock is
expected to trade somewhere in a 10% range up or down Keep in mind that the quoted implied volatility number could
be different for each stock or ETF. Some stocks might
“Kirk, who comes up with this number?” Funny you should naturally experience more volatility compared to others. An
ask because you do! Well, not you in particular, but market implied volatility reading of 35% on Facebook could be a
participants and investors, just like you determine this reasonably low reading for such a large tech company. In

.
fi
.
contrast, an implied volatility reading of 35% for Exxon remaining constant. Delta values can also be used as a
Mobile might be very high for a large, stable oil and gas proxy for an option contract's reaction to directional price
company. It's all relative, so we use implied volatility ranking changes in the underlying stock shares
to normalize the stocks and ETFs we monitor
2) Gamma
Option Greeks
Gamma is the rate of change in an option's Delta per 1-point
When setting up and monitoring positions, traders often use move in the underlying stock's price. You can think of
or discuss option greeks. There are four main greeks, Gamma as an important measure of the convexity or rate of
including Delta, Gamma, Vega, and Theta. A common change of an option contract's value in relation to the
misconception is that the greeks predict the future movement underlying continuing to move either further in one direction
and value of an option contract. It is not true. They are not or closer to expiration. Gamma risk, or the risk of large price
predictive but rather are simply elements that re ect what movements in the option contract, increases as you near
"could" happen in pricing changes for different market expiration
situations. Below, I'll brie y cover each one as we'll use some
of these greeks in subsequent chapters for covered calls 3) Vega
1) Delta The option's Vega is a measure of the impact of changes in

the implied volatility on the price of the option contract.
Delta measures the extent to which an option contract is Speci cally, the Vega of an option expresses the theoretical
exposed to changes in the price of the underlying stock. change in the price of the option for every 1% change in
Delta values can range from 1 to –1 depending on the option underlying implied volatility. Keep in mind, as we discussed
contract you are trading and represent the theoretical change earlier, small changes in implied volatility could have
in an option's price following a $1 increase in the underlying signi cant impacts on an option's price, particularly option
stock price contracts further from their expiration date
Deltas are always positive for call options and always

negative for put options. This is because a $1 increase in the
underlying stock price should always increase the value of 4) Theta
call options and decrease the value of put options, all else

fi
fi
.
fl
.
fl
.
The last major greek is Theta. Theta is the decay of an

option's price due to time. Theta values are always negative
for both call and put options and will always result in zero-
time value at expiration. Often, traders refer to it as the "slow
drip" or "silent killer" of option buyers since it slowly erodes
positions
As expiration approaches, Theta speeds up, and the rate of

decay of the option contract accelerates as it runs out of
time. For option buyers, Theta can be death by a thousand
cuts. On the other hand, option sellers consider Theta decay
an important component for many income-based options
strategies
Conclusion
Alright - Whew! That was a lot of basics to cover, and

hopefully, you didn't skim through this chapter as there are
some golden nuggets in there you won't often nd in other
'Options Basics' write-ups online. Now that we have got
these covered, no pun intended, it's time to shift our attention
to the options strategy so very few stock traders take
advantage of, the covered call

.
fi
Chapter Two
Covered Calls
assigned by the option buyer, to deliver shares of stock at the
strike price on or before expiration. It's referred to as a
When introducing covered calls to new traders, covered call because when you sell the call option, the risk of
we're presented with a challenge: cover the step- assignment is already "covered" given that the underlying
shares are in your possession. Contrast this with a "naked"
by-step details on how to set it up or the overall
call option in which case you have no underlying shares to
framework on "why" we use them before diving cover the risk of assignment and would have to come up with
deeper the money if the stock went against you to cover a loss
While there's certainly no right or wrong way to go about it, NOTE: Naked call selling is nothing bad at all as it requires
we feel that rst covering the overall framework of a covered much less capital than a traditional covered call, mainly
call seems best to set the stage for our discussion. Don't because you don't have to purchase the shares of stock rst.
worry if it sounds complicated at rst, we will be talking in We don't want you to write it off, no pun intended, as it's one
more detail about exactly how to set up a covered call and of the core foundational elements of many other option
how it works later on in the book. The goal here is just a strategies that don't involve stock
quick snapshot and overview of what a covered call is
broadly as a means to help build a more solid foundation Covered Call Payoff Diagra
moving forward The covered call payoff diagram is constructed on the next
What Are Covered Calls? page for you. The dotted blue line represents the payoff line
for long underlying shares of stock. The green dotted line
A covered call is an options strategy that combines the use of represents the payoff line for a single short call option at a
long underlying stock to cover the sale of a short call option. strike price near where you purchased long stock. The red
Yes, you are going to be selling options contracts. No, you solid line shows the combined payoff when both the long
are not going to buy options stock and short call option are combined into a covered call
strategy
Traditionally speaking, a covered call strategy would require
that you already own the underlying stock or ETF shares in
your account before selling the call option. Because you are
selling a call option, this means you have the obligation, if
Chapter Two Option Alpha © 2019. All Rights Reserved. 21 of 65

.
fi
.
fi
.
fi
Who Can Trade Covered Calls
Covered calls can be traded in practically any brokerage

account type; retirement, IRA, 401k, margin, etc. Since you
Long Stock already own the stock and therefore have one part of the
strategy in place, brokers allow you to sell a call option
Profit
against that stock that you own if you choose to do so. You'll
Covered Call also hear this referred to as "writing" a call option which is
used interchangeably with "covered.
The best way to think about a covered call, in our view, is as

a strategy to pre-sell your current stock shares in the future
at a higher price. Sure, you could sell your shares and close
Los
your position now, but what if you could pre-sell shares at a

Short Call higher price in the future and collect some income along the
Notice that the slope of the red payoff line shifts from upward way should the shares never reach that level? Sounds too
Low Stock Pric High Stock Price
and to the right to at and stable at the strike price of the good to be true? It's not
short call option. At this junction, the gains on the long stock
shares are directly offset by the losses on the short call By selling the short call option as part of a covered call
option contract. However, in exchange for capping your gains strategy, you are effectively just pre-selling your shares. More
on the stock, your break-even point or cost basis on the speci cally, you are pre-selling the right to buy your shares to
shares is reduced by the amount of the premium collected. someone else. Straightforward enough, right? The call option
The reduction in net cost to own the shares increase the buyer, in this case, is not obliged to purchase the shares from
probability of being successful with the overall position you, they are just buying the right to do so if they choose,
and in exchange for this opportunity, they pay you an option
Visually, you can see this in the graph as the new payoff line premium upfront. The price at which you feel comfortable
for the covered call strategy (red) crosses over the break- selling the rights to your shares is the strike price of the
even threshold much further to the left, which represents contract. The money you collect upfront from the call option
lower stock prices. The stock could fall in price and you could buyer is the option premium or option price
still make money overall

s
fi
e
fl
.
"
Let's use a straightforward housing analogy to drive home we’ll assume you do want to own a bunch of stock for some
this concept. It would be like owning a house and signing a reason or another
contract for another person to buy your house, which you
already own (stock shares) at a predetermined price (strike Why Should You Sell Covered Calls?
price) by a speci c date in the future (expiration date). In As great as stock ownership is, or isn't depending on who
exchange for you agreeing to sell them your house and you talk to, the question now is about the utility of doing a
taking it off the market until expiration, they might pay you a covered call strategy. Why use covered calls at all? If I had to
deposit (premium) to compensate you in case they don't boil it down into one main factor, the main reason for using
come through on their end and purchase the house the covered call strategy would be cost basis reduction. Said
In this example, you are the owner of the underlying stock another way, by selling a short call option above where the
(your house) and the call option seller. The new buyer you stock is trading and receiving the option premium from the
sign the contract with is the call option buyer. Honestly, it's option buyer, it reduces the cost of owning the shares by the
not any more complicated than that, so let's dive a little amount of the premium
deeper into a covered call strategy and look at how and why This reduction in cost basis via the premium collected, moves
you would set one up for your portfolio. Though we brie y the break-even point, or the net-cost, on your stock
mentioned it above, I want to reiterate that a key concept you ownership lower. You don’t have to be a rocket scientist to
need to remember when setting up a covered call is that you know then that a lower break-even point increases your
must already be long the underlying stock. Owning stock is probability of successfully generating money and income
known as being long the stock, and without ownership of the
stock, you can't technically sell a covered call How do you gure out the new cost basis or break-even
point? Subtract the option premium you received selling the
That said, one of the signi cant bene ts new traders see with short call option from the initial cost of the shares you
a covered call is that you don't have the hassle of handling purchased. Do this just once on a calculator, or in your head,
the shares during an assignment. If the call option is and you can quickly see why selling covered calls is a
assigned, the broker simply takes the long stock shares from pro table strategy long-term when executed repeatedly
your account that acted as collateral. We will debate the
merits of stock ownership later on in the book, but for now, JPM Covered Call Exampl
Let's practice with a simple example

fi
fi
fi
.
fi
e
fi
.
fl
.
• You spent $115 per share to buy 100 shares of What is so exciting to us about combining the long stock with
JPMorgan Chase (JPM) for a total cost of $11,500 an option selling strategy, like a covered call, is that you now
have multiple paths to create a successful trade. It's almost
• You sell a call option with a strike price of $125, which like renting out your stock shares to someone for a set time
expires 30 days from today and receive a $5.00 option period, i.e., until expiration, and they pay you for the privilege
premium ($500 of total value) from the option buyer of doing so. And because you've reduced your cost basis on
• You have now reduced the cost of owning your shares the shares, it turns what would be a 50/50 directional bet on
to $110 per share or a new total ownership cost of just the stock into an overall strategy that has a much higher
$11,000 probability of success
Can you immediately see how powerful the strategy is for the Think about it for a second. Do you have a higher probability
covered call writer, i.e., you? If the stock goes down, you've of success owning JPM stock at $110 or $115 per share?
already reduced your break-even point to $110 per share. Self-explanatory right. Plus, if you own shares in stocks
You still might lose money if the stock continues to move which don't pay dividends, it's an excellent alternative for
lower, but your overall risk is reduced because of the covered collecting income from growth-focused companies by
call you sold. If the stock trades sideways in a range or leveraging the power of options contracts
anywhere below $125 (strike price), you keep the entire Now, imagine that instead of going through this process just
premium from the call option you sold ($5.00). If the stock one time, you replicate a covered call strategy multiple times
rallies, then you are capping your pro t to just $15 per share, each year, over dozens of years. Oh yes! You see, we've
which is the strike price of $125 less the net cost of the only skimmed the surface because the example mentioned
shares of $110 above was a single covered call in a single expiration month.
Many investors consider this last aspect of "capping your Imagine if you sold a covered call through the year for
returns" to be one of the downsides to selling covered calls. multiple years? The constant and relentless premiums you
We would remind them, however, that if you get to the point collected would slowly chip away at your cost basis in the
where the stock rallies beyond your strike price, you've still underlying stock, effectively allowing you to invest in the
made $15 per share in pro t in a month’s time. Are you really stock at lower and lower prices
going to be greedy about making money? Probably not At this point, we know that you're getting excited and
motivated to sell your rst covered call. We've been teaching

.
fi
fi
.
fi
.
this long enough to know when the light bulbs start to turn on. Often in the world of investing, options trading gets bad
Maybe you think you've found the holy grail of investing. And press, or you hear that the only way to make money is
while we don't want to dampen your enthusiasm, we do need through index investing, but it's just not the case, and the
to discuss the risk involved in selling covered calls. Because data proves otherwise. So let us present the facts using third
even with all the bene ts of trading covered calls, there's one party validation
signi cant, glaring downside risk to the strategy that's always
present; the stock itself Covered Call Performance vs. S&P 500 (Fig. 1
It might be a hard pill to swallow for long time stock investors, The Chicago Board Options Exchange (CBOE) put together
but the facts are what they are. Stock ownership is a risky a set of benchmark indexes for different options strategies to
and inef cient use of capital that often overshadows all the show what the result of each strategy would be when traded
bene ts of executing a covered call strategy. We'll discuss in against the S&P 500 Index, as well as other global
a later chapter how you can reduce this risk using options, benchmark indexes such as the MSCI EAFE Index. They
but for now, we think it's important to point out that owning included covered calls in this approach by creating the “30
shares still means that you carry all the downside risk of the Delta Buy-Write Index," which tracks the performance of
stock falling lower in a sell-off or crash scenario. While this selling covered calls while also being long the S&P 500
doesn't happen often, it doesn't mean it won't ever happen or index. The ticker symbol for the index is BXMD. Each month
won't happen to you at some point. Just be conscious of the the index would sell a covered call at a 30 delta strike price
risk against on the S&P 500 and kept doing this month after
month, year after year. The CBOE tracked performance
Do Covered Calls Beat The Market? going back to 1986 until 2018, and these are the results
At this stage, it seems we've done as much theoretical setup The S&P 500 annualized total return during the 32 years was
as we need, and it's time we shift our attention to some hard 9.80%. The covered call strategy (BXMD), on the other hand,
data on covered calls performance. Some of you might be witnessed an annualized return of 10.20%. To put this into
cynical, rightfully so, and wondering how pro table covered perspective, for every $1 invested, the S&P 500 returned
calls were compared to the overall indexes? Or if the sub-title $20.85, and the covered call strategy returned $23.65. That's
to the book, "1 Hour Per Month Strategy That Outperformed more than a 13% outperformance! But that's not all; the
The S&P 500" was just a bunch of hot air to lure you into numbers and data get even better when you look at portfolio
downloading this book variance and volatility metrics

.
fi
fi
fi
.
fi
?
fi
)
Figure 1: Value of $1 Invested - S&P 500 Return (SPX) vs. CBOE 30 Delta Buy-Write Index Return (BXMD)
$30
$25
$20
$15
$10
$5
SPX BXMD
$0
1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
During their research over the 32 year period, the standard created far lower volatility in your account. Isn't this what all
deviation, or portfolio volatility, in the S&P 500 was found to investors are seeking? Better returns with fewer ups and
be 14.90% with a maximum drawdown of -50.95% at any downs in your account and more consistency? By now, it
given time. The covered call strategy (BXMD) on the other should be abundantly clear that the covered call generated
hand, saw reduced volatility at just 12.80%, with a maximum an excess return, or Alpha, above the market benchmark,
drawdown of -42.73%. That. Is. Crazy and with lower volatility or swings in your portfolio
Not only did the covered call strategy outperform the market And while this is only one of the hundreds of case studies
by generating more money overall for the portfolio, but it also that prove covered calls work, it's one of the more in uential

.
fl
ones in our opinion because it was executed on the S&P minutes of your time and execute a covered call (or
500. The very index that everyone says you can't beat, and something even better we'll discuss later on in the book) and
you should simply buy and hold, yet underperformed a start outperforming the market with more consistency. It’s a
straightforward covered call strategy. The CBOE's ndings no-brainer
show without a doubt that options trading, when used
correctly, can enhance your portfolio returns while also Better Covered Call Performance
smoothing out the volatility As great as all the data and numbers were in this chapter, the
NOTE: The CBOE provides the daily and monthly data for next logical question you should be asking is, "can we do any
each index and strategy for free on their website if you want better?" Yes actually! The CBOE only gives the results of two
to double check the results for yourself. We included a link to covered call variations; a 30 delta short call (BXMD) and a 50
the CBOE website in the appendix to this guide, as well as delta at-the-money short call (BXM) both 30 days from
additional backtesting research we have performed here at expiration. But there are many more strike prices and days
Option Alpha that cover a wider array of tickers and covered until expiration for option contracts available to trade. How do
call variations we know that the parameters the CBOE used for their
indexes are the most pro table for you
Once you get familiar with which strike prices and expiration
months to choose, you could do this in the same amount of Well, our research team set out on a new mission and
time it would take you to check your Facebook status or send decided it was time to analyze the popular covered call
a text message to a friend. We said in the book sub-title that strategy from all angles. We spent many months of research
it takes an hour to implement. We lied. It probably doesn't examining approximately 20 years' worth of data (beginning
take that long at all, and we are assuming you have to walk of 1999 to mid-2019) across 109 popular underlying ticker
to a library, uphill both ways, in the snow, use dial-up internet, symbols and 5,550,676 covered call trades. We found clear
and move with all the lighting speed of a sloth. Instead, we and convincing evidence that covered calls work best only
honestly believe that this strategy, once a month, could be within the context of a particular set of market environments
set up and executed in less than three minutes Spoiler alert! Though the CBOE’s 30 Delta Buy-Write Index
So, do yourself and your wallet a big favor, stop checking (BXMD) did outperform the S&P 500, when we analyzed the
email or social media just one time during the month. Just performance of a 30 Delta covered call entered 30 days from
once. Give your money, your family, your future three expiration we found it to perform very poor compared to other

!
fi
.
fi
.
covered call setups. Does this mean covered calls won’t

work? Nope; they do work. It’s just that we found more
attractive setting to use
We wrapped all the research and analysis up for you in a

beautiful report on Covered Call Performance. You can nd a
copy of this report, along with all the other backtesting
research we do at Option Alpha, on our website. Alright,
we’ve said too much already, and before we go too far down
this rabbit hole, let's continue with covered calls for now and
walk through the details on setting them up in your trading
account

.
fi
Chapter Three
Strategy Setup
It seems simple enough right? It is broadly speaking. But
each step has its unique risks that could cause the entire
Now that you understand the "why" behind strategy to fall apart or at that least not perform at the optimal
covered calls, let's talk about the actual setup level it could. So, let's tackle the rst three steps in this
chapter, which will get you the point at which you can place a
mechanics involved
new trade. We'll save the last step on monitoring and
There are several key steps to go through when setting up a adjusting positions for the next chapter
covered call. In this chapter, we'll review the step-by-step
NOTE: Throughout this book, we refer to the underlying
process and look at a couple of covered call examples
security mostly as stock ownership in a company. Most
together so that it's clear how to implement it in your account
investors who transition into covered calls do so via
You should rst understand that the entire process we are ownership in individual company stock. However, it should be
going to cover takes seconds to execute and ll in the noted that you can and should sell covered calls on ETFs.
market. The reason we bring this up now is that in our So, please don't misunderstand our use of the word "stock"
opinion, there is no excuse for not performing this in your to mean that we only suggest initiating covered calls on
brokerage account immediately after reading this book and individual companies - we don't. We believe you can and
our performance research report mentioned at the end of the should sell covered calls on any underlying you have an
last chapter. Every single stock investor should be executing ownership in, stocks, or ETFs
covered calls at one point or another. But we digress, let's
Step 1: Own or Purchase Long Stock
get into it, shall we
With so many stocks to choose from, it can be daunting to
Here's the step-by-step guide we'll follow as we progress
know where to start. And before we get any further, let's be
through the chapter
clear with the following point. There is no single answer as to
1. Own or Purchase Long Stoc which stocks you should or shouldn't pick to set up a covered
call strategy; it's ultimately a personal decision you have to
2. Select Expiration Date or Contract Mont make on your own
3. Choose the Call Option Strike Pric The purpose of this section is not to tell you which stocks to
trade covered calls on, instead, offer some key decision
4. Monitor & Adjust Position As Neede
Chapter Thre Option Alpha © 2019. All Rights Reserved. 30 of 65

e
fi
.
fi
e
fi
.
points that might help you decide which stocks are suitable positions and at better prices. This step is crucial and
for your account and investing pro le. We believe there are requires a little more digging and research, so take your time
three main factors you should take into account when it and get it right
comes to choosing your underlying stock or ETF. We'll brie y
touch on each of these areas to give you a clearer picture of Liquidity is a uid thing, pun intended. What seems like low
what types of information you should be looking for when liquidity for one stock might be high for another. For example,
choosing stocks or ETFs GOOGL and AAPL are higher-priced stocks, which means
you don't need to sell as many covered calls on them to
Factor #1 - Optionable Stocks & Liquidity Filters generate high option premiums. Other lower-priced stocks
like WFC or BAC leave room for you to not only purchase
By now, it should be evident that you cannot use a covered more shares at a lower price but then require that you sell
call option strategy on a stock that isn't, well, optionable. It'd more covered calls to capture the same premiums as selling
be like trying to drive a car without wheels; it's just not going one or two calls in higher-priced stocks. There's no right or
to happen. Therefore, the easiest and quickest way to lter wrong answer necessarily since it's all relative, so here are
the possible universe of stocks and ETFs down is to rst look the key points of focus when reviewing the liquidity of the
at the availability of options. Second, the liquidity of the options market
options contracts for each underlying
First, make sure there are a variety of contract months
Surprising as it may seem, many companies still do not have available. You want to see many months of options contracts
a derivatives market for options contracts. Even if you in the option pricing table. Multiple months tell us that there's
wanted to execute a covered call strategy, there might not be a strong demand from investors for buying and selling
a market for options that exist for that security. Naturally, the options in various periods. If the stock or ETF has weekly
rst scan we can run then is to lter for only the optionable options, that's an even stronger indication that the market
stocks. Most broker platforms can easily do this for you in a can handle and support a larger group of investors
couple of clicks of the mouse, so let's continue moving
forward Second, you want to check the liquidity of the front-month
expiration contracts, which expire in the next 30 days. These
Once you nd all optionable stocks, the next hurdle to jump will typically be the most active contracts, and ensuring their
over is ltering for a large and liquid options market. Liquid liquidity is vital to a possible covered call options strategy.
markets allow you to more easily enter and exit covered call

fi
fi
.
e
fi
fl
.
fi
fi
.
fi
fi
fl
The two metrics we'll look at speci cally to judge the liquidity First up is an old favorite of ours that we use often in courses
of a market are Volume and Open Interest and webinars. Mainly because the ticker symbol is GOOD,
and yet the liquidity is anything but good. In fact, it’s nearly
Volume shows us the activity of the options market on a non-existent
given day, and open interest shows us the depth of the
market for contracts still outstanding. You might think about
these two metrics as measuring the depth and speed of a
market, like that of a raging river - the deeper and more
active the market, the better. Shallow, stale markets (swamp-
like) should be avoided and offer minimal opportunity. Ideally,
there should be thousands of options contracts in volume for
a given day and tens of thousands of contracts in revolving
open interest across multiple strike prices
For clarity, each strike price doesn't need to have precisely

1,000 contracts traded in volume or exactly 5,000 contracts
of open interest. What we mentioned above are just
guidelines or road markers you might use as you scan for
possible investments. You'll learn to quickly recognize
excellent liquidity by merely looking up and down the options Notice that both the volume and open interest for the closest
pricing chain ATM call options, the $25 strike price, in the next month are
lifeless. Just 6 contracts are oating out there somewhere.
If these two metrics hold up, the tight or narrow bid/ask
Yes, the stock is optionable, but the options are illiquid. If you
spreads will surely follow. This means better pricing and
think that this pool is deep enough to swim in then you’re
easier lls for your covered call. To help train your eyes,
sadly mistaken
we've pulled together some bad and great liquidity examples
below Next up is NNN, a fairly large company that is held within
many ETFs and Indexes as well as traditional investors. Here
Bad Liquidity Example
we’re showing the closest ATM call options which are the $60

.
fi
e
.
fl
fi
.
strike. Yet, once again, we see the lack of liquidity in the options market of any ETF or stock. Here we’re showing the
options contracts closest ATM round strike call option at $310 strike price
Admittedly, it’s not as bad as GOOD on the previous page,

but it’s certainly not liquid enough either. The contract has
much more open interest but it’s still far below anything we
SPY, in our opinion, should be your “north star” when it
would touch. Plus, the volume reading of zero suggests at
comes to scanning for liquidity. It sets the bar very high with
the end of the trading day, when we grabbed this screenshot,
more than 55,000+ contracts of open interest and 24,000+
that the market for options on NNN is extremely quiet
contracts traded today. Not this week or yesterday; today!
Great Liquidity Example And this is only on a single call option strike price in a single
expiration period
Enough with the garbage liquidity examples. Let’s review
some amazing liquidity examples. Naturally, the rst one we’ll Let’s pull up one more example and look at the call options
review are the call options for SPY, which has the most liquid for GLD, a major gold ETF

e
.
fi
.
Filters for fundamental or technical analysis could have been

the number one item on our list for choosing a stock. Still, we
wanted you to focus on the liquidity of the underlying options
because, without that, it'd be pointless to review the next
steps. All the analysis in the world would be worthless for a
covered call investor if you cannot trade liquid options
contracts on your prized stock pick, right
Now, you're a pretty smart person if you're reading this book,

and chances are you've done well enough to have some
money set aside for investing purposes. Most new covered
call traders, therefore, are well-versed stock investors and
already study or should be studying, company nancials and
earnings reports. Therefore, one of the rst ways you can
Looking at the $139 call strikes, which is the closest ATM lter the universe of stocks to purchase for a covered call
contract, we see both open interest and today’s volume in the strategy is to use fundamental analysis lters. There are
multiple thousands. This call option isn’t as liquid as SPY but many hundreds of lters you can use, and we don't dare pick
it’s within our general guidelines. If you are trading a handful any here that you would focus on since the best indicators
of covered calls, you’ve got more than enough room to get can vary per industry or sector. Instead, we'll list some of the
contracts lled without much of a struggle. more popular lters being used for you to explore in your
spare time
The question now is, do you always need to trade tickers as
liquid as SPY and GLD? Nope. The goal is to distinguish • Price to Earnings (P/E) Rati
between bad and great liquidity. So long as you follow the
• Price to Cash Rati
general guidelines we’ve presented earlier, you should nd it
fairly easy to enter and ll orders • Debt to Equity Rati
Factor #2 - Fundamental or Technical Analysis Filter • Forward P/E rati
• Price to Free Cash Flo

fi
e
fi
.
fi
o
fi
o
fi
o
fi
fi
?
fi
fi
s
• Earnings Per Share Growt The second way you could lter for possible securities to
purchase for your new covered call strategy is to use a
• Price to Book Rati combination of technical analysis indicators. Technical
• Dividend Yiel analysis is a method of examining past market data to help
forecast potential future price movements. Using different
• Cyclically Adjusted P/E (CAPE) Rati tools, indicators, and charts, investors can often generate
signals that leverage current and historical market data to
• Many more..
anticipate a stock's future or projected path
Personally, if we were forced to purchase long underlying
Often this means that you'll be trading in and out of
shares, we'd choose companies or ETFs with a long history
underlying stock more often and on shorter timeframes. It
of paying a stable, high-yielding dividend trading at a low
likely won't be day trading but rather what we call "position
CAPE Ratio. An ETF yielding 4-5% per year in dividends
trading," in which case you might hold a stock position for a
helps to reduce costs basis and smooth returns over time.
few weeks or months between entry and exit signals. During
Couple this with a simple covered call strategy, and you now
this time, you can sell covered calls to further increase your
have, not one, but two ways to reduce costs basis and
probability of success on any long stock positions you enter
generate income on an underlying which further increases
your chances of success. Multiple streams of income are This all sounds very sophisticated and cool. Use some secret
always more stable and attractive in our book indicators that predict stock movement while you're sipping
drinks on a beach somewhere. The truth is that most
Whatever you choose or however you analyze the
technical analysis indicators are terrible predictors of market
fundamentals of a company, if you plan on owning shares for
direction and stock returns. How can we be so bold as to
the long haul, you'd better have a solid understanding of the
make this claim? Well, we had our research team spend an
business, it's growth, the industry they are competing in, etc.
entire year testing the validity and predictive power of the top
Don't invest because you love the founder or CEO. And
17 most popular technical analysis indicators. We tested and
please don't invest because of a tweet, post online, or article
analyzed more than 1,476 indicator variations over 20 years
you read in the newspaper. Invest for value and expected
to see which worked and which did not
returns. Buying stock is buying ownership in the company,
and you should never forget this Not surprisingly, only a few indicators and speci c settings
generated reliable signals and excess returns above the

e
.
fi
.
fi
.
market. To put even more context on this, less than 5% of all You want to get a decent idea of what the option premiums
the variations we tested had predictive power in a stock's are you'll be receiving if you start selling covered calls. It
future direction more signi cant than 50% accuracy. In might take some monitoring, and you should watch how
English, this means that the vast universe of indicators out option pricing changes during a couple of different expiration
there, for all intents and purposes, are less predictive than cycles for your target stock. Besides, if you're planning on
ipping a coin. Of those in the 5% bucket, only a tiny handful investing in stock for the long haul, what's another month or
was signi cant enough to use for investing purposes two of analysis to make sure it's the right move for a covered
call? We think you'll nd that patiently observing for a small
What's the moral of the story for technical analysis? First, period of time results in more con dent decision making, and
you don't have to use technical analysis to trade covered ultimately more pro table investments
calls. Are they required? Nope. Can they help? You bet. And
if you are going to use them, it's essential to use the best What should you look for, or what benchmark should you use
indicators and settings. Anything else could be damaging to then for covered call yields? As far as targets are concerned,
your likelihood of success. Once again, we did the research a great guideline would be to collect around a 1% premium to
for you and published all our ndings in the ground-breaking stock price yield per month. We use the word "collect" here
publication called The Signals Report, which you can nd on speci cally as we're referring to the option premium or option
our website price at the time you initiate the covered call. For instance, if
a stock is trading for $100 per share, you might have a target
Factor #3 - Covered Call Yield & Return Filters to collect approximately $1.00 of option premium per month,
If you've checked all the items above and nd a company or on average, selling covered calls
ETF with a liquid options market that you want to own, the The premium you collect may or may not be the nal pro t on
last lter is to run a couple of simulated trades. These allow a single position.This is a general guideline, and you can, of
you to double-check the covered call yields and returns you course, go higher or lower than this gure. As a starting point,
might expect moving forward. Although you might be very you could sell the 30 Delta call options in the one-month
excited to get going by jumping in with both feet, we highly expiration contracts as the basis for your analysis. Recall this
suggest you do some simulated trading over the next couple is the setup that the CBOE uses currently that outperformed
of weeks or months the S&P 500, though we know there are better setups we
could possibly use

fl
fi
fi
e
fi
.
fi
.
fi
fi
fi
.
fi
fi
.
fi
fi
.
fi
fi
Once you add this to the 3-4% dividend yield per year, contracts. A call option 90 days from expiration will lose less
provided your stock doesn't get called away, you will be value per day than the same strike call option 30 days from
receiving a nice regular income of around 15-17% in expiration. The front-month contract is running out of time,
dividends and cost basis reduction overall each year. Not too and therefore, the theta decay speeds up as expiration
shabby, right? Nope, seems pretty attractive nears
There you have it, the three primary factors we believe you When it comes to implied volatility, the roles are reversed.
should review and analyze when choosing your underlying Longer-dated (back-month) options contracts react more to
stock for a covered call strategy. We meant for this to be a changes in implied volatility than shorter-dated (front-month)
little subjective on many levels, as it should be. Trading with options contracts. This is because a small change in implied
covered calls is a long-term investment in stock, and you volatility now, which is extrapolated out over a longer time
should make sure that it ts within your personal goals and period, could have a major impact on the expected stock
risk tolerance levels before moving forward. In the next price
section, we'll help you decide which expiration date or
contract month to target A call option 90 days from expiration will witness its price rise
much higher on a relative basis due to increasing implied
Step 2: Select Expiration Date or Contract Mont volatility than the same strike call option 30 days from
expiration. The front-month contract is less reactionary to
Now that we've got a stock picked and own shares in the changes in implied volatility, which may or may not have
underlying, we'll start using some live examples to enough time to play out before the expiration date. Given a
demonstrate how you might think about choosing the choice, we'd always prefer to start selling covered calls when
expiration date in which to sell your covered call. Before we implied volatility is high, and option pricing is high as a result
keep moving, we want to highlight the general impact of theta
decay (time decay) and implied volatility on options pricing Good so far? Great! Now, let's look at some call options in
again. Recall that an option's premium or price may react different expiration months for SPY. The front-month
differently to theta decay and implied volatility in various contracts expiring in September are approx. 22 days from
expiration periods expiration
Longer-dated (back-month) options contracts erode at a

slower pace than shorter-dated (front-month) options

.
e
.
fi
.
Notice the relative option premiums of the $291-294 OTM to the additional time and volatility (extrinsic value) given to
calls on the right side of the pricing table. They range from the back-month options
$2.23-0.98 per contract
Keep in mind at this stage that since we are selling call

The back-month contracts expiring in October are approx. 50 options, we want to generate the highest return on the option
days from expiration. Notice the relative option premiums of contract as possible while also not impeding the upward
the $291-294 OTM calls on the right side of the pricing table. mobility of the stock. We achieve this when the option
They range from $3.60-2.18, signi cantly higher than the premium quickly falls in value after order entry or goes to
September contracts. The additional premium is mainly due zero by expiration. Granted, we also don't want this to

e
.
fi
happen at the expense of the stock shares crashing, but right One guiding light might be the CBOE's Buy-Write Index
now, we're just referring to the short call option contracts, (BXM), which sells an ATM call option on the S&P 500.
independently of the underlying stock Effectively this is selling a 50 Delta call option every month,
and the results prove the point we outlined above. The
So how far out in time should you sell covered calls? 22 days annualized return of this aggressive covered call strategy
or 50 days? Well, it depends. It may seem like both front, and was 8.50%, with a standard deviation or portfolio volatility of
back-month options contracts have bene ts and drawbacks, 10.60%. These metrics are both less than the 30 Delta call
and you'd be right. The answer then is that you need to align option strategy (BXMD) and the S&P 500 itself. It proves that
the expiration date or contract month with both your selling closer ATM (high delta) call options does help to
willingness to monitor and manage the position and the reduce volatility in the combined strategy, but at the sacri ce
available premium to be collected. Our Covered Calls of overall gains and performance. Naturally, there's a delicate
Performance Research Report will also help guide your balance here that you need to nd that works for you
decision-making process after reviewing the performance of
various expiration periods Continuing with our examples, we'll again look at the same
call options in different expiration months for SPY. Only now,
Step 3: Choose the Call Option Strike Pric we'll assume that we'd like to sell a covered call near a 30
Deciding the nal strike price for selling a covered call might Delta with a target probability of success around 70%. The
be one of the harder considerations an investor has to make closest strike price to our target 70% success level in the
for this strategy. Sell a call option too close (high delta), and front-month contracts expiring in September is the $292 call
you collect a high premium but give the stock very little room options with a price of $1.73 per contract
to move before capping your pro ts at the lower strike price.
Sell a call option too high above the stock price (low delta),
and you collect a lower premium but give the stock more
room to rally higher before you cap your gains with a higher
strike price. There are risks and rewards to each style or
avor you choose so take your time picking on that’s right for
you and your portfolio
ATM Covered Call Performance (Fig. 2

fl
e
fi
.
fi
fi
.
fi
)
fi
Figure 2: Value of $1 Invested - CBOE Buy-Write Index Return (BXM)
$30
$25
$20
$15
$10
$5
SPX BXMD BXM

$0
1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

e
The closest strike price to our target 30 Delta and 70% Which one do you pick? Tough question for sure. Ultimately
probability of success level in the back-month contracts the decision is either driven by data, from backtesting
expiring in October is the $293 call options with a price of research, or a personal decision based on your risk pro le
$2.61 per contract and need for either growth or security with your positions.
Here's the trade-off you need to consider which might help
steer you in the decision-making process
If you sell the front-month options, you will collect a lower

premium at a strike price that's only $2 above the current

e
.
fi
market price. In exchange for the lower premium and higher
risk of the stock breaching the strike price, the stock only has
22 days until expiration, and time is running short. If you sell
the back-month options, you will collect a higher premium at
a strike price that's $3 above the current market price. In
exchange for the higher premium and further out strike price,
the stock now has more time, 50 days until expiration, to
move against your short call.
Conclusio
If you've followed the rst three steps outlined in this chapter,

you're now ready to enter your rst covered call trade
of cially. With all the pieces together, the process of actually
placing the order in your broker platform should be relatively
straight-forward. You already own the stock (or are
purchasing it) and have selected your target expiration date
and strike price of the call option contract. Now, place the
order and turn the page. If you still need help or have
questions, please reach out to our team at Option Alpha.

fi
e
n
fi

fi
Chapter Four
Position Management
NOTE: In the Options Basics chapter, we walked through a
similar framework, but at that time, it was explicitly dealing
If you've reached this chapter, you should have with single long call and put options. In this exercise, we'll
your new options strategy executed and working approach this only from the standpoint of a covered call
investor
its magic. In essence, you've made it. You're an
options trader now To help build some context for our discussion, let's assume
the following options pricing table exists for the ticker EWW
Earlier in this book, we reviewed the overall strategy of a (iShares MSCI Mexico ETF)
covered call, proved using the CBOE data that they can
outperform the major stock market index, and nally helped
you determine the right expiration months and strike price
ranges to target. And since you're on a new level with your
trading, we'll assume you're also smart enough to know that
it's not always roses and sunshine trading covered calls
Stocks do move down from time to time - shocking right. So,

what happens now? Now that you've got this covered call
strategy working, how do you manage or adjust the position if
it starts to go wrong
First, don't worry; we wouldn't have carried you this far to

abandon you now. In this chapter, we're going to take a look
at all of the different scenarios that could happen with a fully
executed covered call position and how you should react or
adjust your position if necessary. Remember to always take
your time and work slowly. There's never a need to rush the
process
Chapter Fou Option Alpha © 2019. All Rights Reserved. 44 of 65

.
r
?
fi
.
With this pricing table in front of us, we’ll also assume the of this section, we'll also suggest ways to hedge or adjust the
following covered call strategy is executed trade to reduce risk. Let’s start with the best outcome
1. ETF is trading currently for $51.73 per share Outcome #1: Stock Rallies Above Strike Pric
2. You purchase 500 shares at $51.73 for a total cost of One of the most common concerns options traders have
$25,865 when setting up a covered call strategy is what happens
when the stock, EWW, in our example, rallies above the
3. Your target for the covered call is the 30 Delta strikes strike price of the short call option you sold? Does this mean
representing a 70% probability of success that your shares will be "called away" or exercised and
4. You sell the $52.50 strike call options for $0.89 in option assigned immediately to the option buyer? Should you buy
premium per contract back the short call option to keep the stock position or let
your stock be called away? Well, there are several points we
5. You sell ve contracts that cover the 500 shares you just need to cover to answer these questions
purchased
First, the most important thing to understand is that just
6. The call options expire in 22 days from today because EWW rallies higher, does not mean you will
automatically lose your long shares. Most assignment of
7. The cost basis on the shares of the ETF is reduced to
stock by the call option buyer happens the week of
$50.84 because of the premium collected
expiration, and more speci cally, the last few days of
8. The total premium of $445 is subtracted from the original expiration. At that point, the option contract has little to no
total cost to a new, net total cost of $25,420 extrinsic value left. So, if the stock rallies above your strike
price but you still have 20 days to expiration, there's a high
9. You have reduced your cost basis on the EWW shares by probability you will not get assigned by the option buyer
1.70%
With 20 days left, there's still a decent amount of extrinsic
Now that you’ve got your trade setup and working in EWW, value left in the contracts, and the option buyer would forfeit
there are ve possible outcomes and corresponding potential that extrinsic value by assigning the option contract in
actions you could take. Where appropriate towards the end exchange for shares early. They won't do that because it
would be nancially unwise to do so. However, if you were to

.
fi
r
fi
fi
.
fi
.
wait right up until expiration and the stock was still trading Hitting lots of singles as opposed to swinging for home runs
higher than your strike price, then you are at greater risk of is an excellent strategy for generating consistent, reliable
your stock getting assigned and called away income. And, well, higher overall returns with less risk in the
process. Need a refresher? Go back two chapters and re-
Let's assume for whatever reason that your EWW shares are read the performance of covered calls vs. the S&P 500.
exercised and assigned to the option buyer, and you no
longer own the underlying stock. Well, remember when Outcome #2: Stock Rallies, Stays Below Strike Pric
mentioned earlier in the book that this might be one of the
best-case scenarios? Having your stock assigned is not a This outcome is the second most favored among covered call
bad thing; in fact, it might be the ultimate goal because, after traders. If EWW rallies but the shares remain below your
all, you wanted the stock to rally higher, didn't you? That strike price of $52.50 at the end of the expiration cycle, then
said, some people get upset that they didn't participate in the the options contracts expire worthless, and you don't need to
new higher stock price above the strike price level. And we do anything. As the call option seller, you get to keep the
understand that concern, but these strategies have capped $445 premium you collected from the buyer as pro t, and you
upside pro t potential in exchange for a much higher also get to keep your long shares of stock since the stock
probability of success. You can't have your cake and eat it never breached the strike price. The stock value increased,
too and you kept the entire option premium as pro t, win-win.
Now, go sell another covered call and repeat the process all
The pro t you can receive is limited to the difference between over again next month
the $52.50 strike price and the $51.73 stock price when you
purchased the shares, plus the credit received from selling
the out-of-the-money call, $0.89. If EWW rallied well above Outcome #3: Stock Moves Sideway
your $52.50 strike price, and your stock is assigned, you just
captured all the potential pro t possible in a single expiration A highly likely scenario is that EWW trades in a sideways
period. Go ahead, pat yourself on the back. The reason you range around your original entry price. Remember that
got paid a premium selling a call option, $445 in total, is markets are both cyclical and relatively random. Maybe up a
because you forfeited your right to any pro t on the stock couple of days here and there, down some other days,
beyond the $52.50, and that's okay ultimately moving sideways with no clear direction. If this

.
fi
r
fi
.
fi
.
fi
.
fi
fi
e
happens, then this outcome is probably the third-best one money and will expire worthless, freeing you up to re-
you might expect establish another short, possibly at a closer strike price in the
next month
At expiration, you didn't lose any value on the stock you own,
but you also get to keep the entire $445 option premium as All that being said, you should continuously re-evaluate the
pro t from the short covered call. Sure, you didn't see the EWW position and make sure you are still comfortable
stock rise in value, yet you got paid for waiting around, selling owning shares. The cost of owning the shares takes up the
the covered call, and reducing your cost basis on the shares bulk of capital for the position. Therefore, the stock itself is
in the process. Now you can re-establish a new set of short the most critical factor to monitor
call option contracts in the next expiration month and repeat
the entire process If you decided you want to sell the stock, you need to rst
close and buy back the short call option or wait until your call
Outcome #4: Stock Trades Lower, Continues Fallin option has expired. Exiting the stock position while leaving
the short call option open and working would expose you to a
Let's be honest, rational adults with each other for a moment. short naked option position. This translates into potentially
There's a 50/50 chance that your beloved EWW shares go higher margin requirements and additional risk you may not
down at some point during your covered call expiration cycle. want
Yes, this means that not all stocks go up, and it will happen
to you at some point. But since you are selling covered calls, Outcome #5: Stock Has Upcoming Dividen
you're doing yourself a big favor when it comes to cost basis
in this unfavorable scenario This scenario is speci c only to those stocks and ETFs that
pay dividends. In our example, we selected EWW speci cally
Because you sold a call option for a premium, your new because it does pay dividends quarterly, in which case we
break-even point, or cost basis, on the stock was lowered to can walk through the scenario without changing ticker
$50.84 per share. Therefore, the stock could effectively drop symbols. Before we go any further, please understand that
from $51.73 to $50.84, and you would not lose money overall dividend payments and early assignments as a result of
on the combined covered call strategy. Any drop below dividends will not occur as often as you think it might
$50.84, and you would lose on the overall strategy due to the
decline in the underlying stock shares. At expiration for this You should always be aware of when your stock or ETF pays
fourth outcome, the short call option is now far out-of-the- monthly or quarterly dividends. Not only because you'd want

fi
.
r
.
fi
.
fi
g
fi
to collect this money as the stock owner, but also because it might seem a little complicated at rst, but it's a
you could be at risk of early assignment. How does it work, fundamental concept
and why should you care about dividends payments and
dates as a covered call investor? Let's discuss The question naturally then is, what does the put option strike
price have to do with our covered call option? Think back to
When a stock or ETF, like EWW, is about to pay an upcoming the rst chapter on Options Basics and recall that the goal of
dividend, the risk of early assignment increases dramatically. the call option buyer on the other side of your contract
The kicker is that the risk of early assignment only impacts originally was to take a risk de ned, bullish position on EWW
those call option strike prices that are deep-in-the-money. stock. Their risk was limited to the premium they paid you of
These would be the call option strikes that are below the $445, and in exchange, they get all the upside potential
current stock price. These contracts could potentially be at beyond the $52.50 strike price and their respective break-
risk of early assignment because the call option buyer, on the even point
other side of your trade, might be motivated to exercise their
contract early If they now are interested in assigning the option contract,
they would only do so when they can use the money
The call option buyer would choose to do this in order to collected from the dividend to immediately purchase a long
purchase shares from you and collect the upcoming dividend put option at the same strike price as the original call option.
payment. Seems rational, right? But how can you tell if the It sounds complicated, but it's not. The call option buyer is
particular strike price of $52.50 that you are holding is at risk willing to go through the exercise process to assign shares;
of early assignment of your shares? It's straightforward, however, only if they can use the money collected from the
actually. dividend to become risk de ned again
To determine if your short call option is at risk of early Holding long shares of stock while also purchasing a long put
assignment, look at the price of the corresponding put option option for protection is the same synthetic position as a long
contract at the same $52.50 strike price. Short call options call option. It's the same payoff diagram, just constructed with
are at risk only when the value of the corresponding put different components. In this case, all the call option buyer
option at the same strike price of $52.50 is valued less than would do is use the money from the dividend payment to
the dividend payment scheduled. You should re-read that last nance or pay for the purchase of a put option contract for
sentence again, potentially two or three more times, because protection against the stock shares

fi
fi

r
.
fi
fi
.
fi
.
Let's walk through an example assuming that EWW is now It should be evident now that not all in-the-money (ITM) call
trading at $55 per share, making your $52.50 strike call options are assigned just because they are ITM. This is a
option an ITM position. This week EWW announced it will be common misconception about the early assignment of a
paying a $0.35 dividend per share. On the day before the short call option as a result of dividends. Just because your
stock trades ex-dividend, the corresponding put option at the option is ITM around the time of dividend payment, doesn't
$52.50 strike price in the same expiration period as your mean you are at automatic risk of assignment. It is only if
short call option is trading for $0.30 per contract. In this your call option contract is ITM, and the corresponding put
scenario, you would be at risk of early assignment of your option at the same strike price is valued or priced less than
call option contract and here’s why the dividend payment
The call option buyer could exercise the call option contract, Have a look at your broker platform on the day of ex-dividend
purchase shares at the $52.50 strike price from you, get paid to check if you are at risk of an assignment or not. If you are
the dividend of $0.35 per share, and use $0.30 to at risk, then you either need to close out the call option
immediately purchase a $52.50 strike put option contract for contract or roll it over to the next month, discussed next,
protection. Effectively getting them back into the same risk where option premiums are higher. Assignment happens on
de ned, bullish position in EWW only now a little richer by the day the stock goes ex-dividend so make sure you know
$0.05 per share. Bing, bang, boom when this is so you can be one step ahead and not caught off
guard
Alternatively, let's assume that the same stock price setup
exists as above, only now the corresponding put option at the Covered Call Adjustment & Rollin
$52.50 strike price is trading for $0.50 per contract. In this
scenario, the call option buyer would not exercise their It's easy to sit back and watch the pro ts roll in as the stock
contract and assign shares. It would cost them more money you are trading rallies higher during the expiration month.
overall to buy shares at $52.50, collect the dividend of $0.35 This happens about 50% of the time and requires no effort on
and then pay $0.50 to purchase the put option protection. It your part. Go ahead, keep kicking your feet back and sipping
would be nancially a net loss plus they are better off to keep your chilled drink
the call option contract and forgo assigning you, the call The other 50% of the time, the stock falls during your
option seller expiration period. When this happens, there are a couple of
ways to adjust and manage the position to reduce risk. Note,

fi
.
r
fi
.
fi
we're not talking about fully turning the position around into a move in the market by increasing your overall credit. The
winner all the time, but instead taking a potentially signi cant adjustment reduces your cost basis on the EWW shares
loss and cutting it down into a smaller loss even lower and moves your break-even point down to $50.34
from $50.84. With the stock trading at $49, you are within
The rst way to reduce risk is to adjust the covered call strike striking distance of a pro t on any small rally in the shares
price in the same expiration month by moving it closer to
where the stock is trading. You may often hear the phrase Yes, at the moment, you're still losing money. But had you
"rolling down," which is just fancy trading jargon that means not executed the adjustment, you would be down even more
closing one strike price and re-opening another, lower strike money as your old break-even price was $50.84. The new
price, typically in the same expiration period break-even price is $50.34. Pretty cool, right? And you can
keep rolling down your call strikes as needed during the
Using our primary example for the chapter, let's assume expiration month multiple times if you want
EWW dropped to $49 per share, below your $50.84 break-
even price. At this point, your short $52.50 call options which The second way to adjust covered calls is to roll the existing
you sold for $0.89 might drop in value to just $0.20 each. You call options from the current front-month expiration to the
could then choose to repurchase these $52.50 call options next, or further out, back-month expiration. In the adjustment
and close them for a quick $0.69 pro t and immediately re- example above for EWW, we rolled call option strike prices
sell a closer call option strike price, say the $51 strike price down from one strike to another strike in the same month. In
that is now quoting a price of $0.70 per contract this second adjustment technique, we are instead rolling the
call option strike out in time to give the stock more time to
The net impact by adjusting your call option strike price lower recover potentially
is that you took in an additional net credit of $0.50 for each
option rolled down. This re ects the premium received from You'll often nd that rolling out in time to the next month
selling the $51 calls at $0.70 each, less cost to buy back the accomplishes the same goal of collecting an additional credit
$52.50 calls at $0.20 each. Your new overall credit from both without having to sacri ce your upside potential selling a
call option sales, the original entry and this new adjustment, closer call option. This works because an option contract with
is $1.39 per contract, or $695 in total more time until expiration is more valuable, all else being
equal. So you might nd that the same strike price of $52.50
The real "magic" when using this type of adjustment in the next expiration month pays the same amount of money
technique is that you are taking advantage of the downward

fi
r
fi
.
fi
fi
fi
fl
fi
.
fi
.
as a closer strike price at $51 in the front-month expiration

we analyzed above
The process of rolling the call option out in time is the same
mechanically as it is for rolling the call option down. You
simultaneously buy back and close the $52.50 call options
that expire in 22 days while re-selling new short call options
at the same $52.50 strike price in the next contract month
that expires in 50 days, for example. The trade-off is that by
rolling a call option out to a further expiration month, you
might have to wait longer for your pro t on the premium to be
realized. On the other hand, because you didn't move the
strike price of the call option lower, you are leaving more
room for the stock to rally
Conclusio
Whichever method you favor as you start monitoring and

adjusting covered call positions, recognize that being
proactive is crucial. When the stock drops and you roll your
short call option either closer and down or out to the next
month, it allows you to increase your overall credit in the
position and ultimately reduces risk. Is one technique more
favorable than the other? Not really. There's no perfect
answer, and each situation is going to be a little different. As
always, you have the option, pun intended, as to which
adjustment technique seems most appropriate for you

r
n
fi
.
Chapter Five
Synthetic Strategies
purchasing underlying stock or ETF shares. You may also
hear people call this strategy a "Poor Man's Covered Call" or
What if we told you that as much as you might "Skinny Covered Call" as well as many other names, but the
have fallen in love with covered calls during our concept is the same. Instead of purchasing 100 shares of
stock, purchase a single (one) deep ITM call option, that
amazing, self-admittedly, blueprint in the last
controls 100 shares, and replicate a stock position for less
couple of chapters, there were better money
alternatives
Why do this? Well, there's no debating that the capital
Alternatives that required less money to get started and requirements for stock ownership can be incredibly high. For
performed practically the same, and in some cases, much example, the Russell 2000 Index EFT (IWM), is currently
better long-term. Alternatives that gave you the ability to trading at approximately $172 per share at the time of this
diversify across more stocks and ETFs and leverage the full writing. To purchase 100 shares of IWM, you would need to
power of options. Starting to salivate yet? Well, it's true, and invest at least $17,200, a gure that is 70% higher than the
we'll show you how. average brokerage account opening balance in the US. All
that money so you can sell one covered call against the stock
In this nal bonus chapter, we'll explore the two main
while still carrying the full downside risk of the market moving
alternatives to trading covered calls without the requirement
lower? No thank you. It seems like a lot of risk, in our opinion,
of purchasing the underlying stock. Yes, you don't have to
to gamble on a single ticker that may or may not work out?
outlay thousands of dollars to buy stock to trade a covered
We're sure you can see our hesitation with stock ownership
call option strategy. Together let's examine these alternatives
we’ll refer to as covered call “synthetics strategies. If we agree then that stock ownership may not be the most
cost-effective way to build a covered call strategy, what else
Synthetic Strategy #1: LEAPS Options
could we do to replicate the 100 shares of stock? We could
The rst synthetic covered call replaces long shares of stock use an option contract of course! Remember that every one
with the purchase of a single deep ITM call option in a far- option contract controls 100 shares of stock. Speci cally, we
dated back-month expiration. This type of call option contract could purchase a call option with a high Delta value, which
is commonly referred to as Long-Term Equity Appreciation would replicate similar performance of the underlying stock
Security (LEAPS). It acts as a synthetic in place of without having to buy shares outright. This is where LEAPS
Chapter Five Option Alpha © 2019. All Rights Reserved. 53 of 65

fi
.
fi
?
fi
”
fi
.
are used by sophisticated options traders to create a covered roughly 50 shares of stock. Call options with a Delta of .70
call synthetic will behave as if you owned 70 shares of the underlying
stock
As mentioned, LEAPS are long-term or back-month
expiration contracts. How far out in time exactly? Well, that's Ironically, because we know where your mind is already
up to you to decide. Generally, any expiration more than six going, Deltas of 1.0 will not exist until you get much closer to
months out from today's date is a reasonable basis for expiration due to the extrinsic value of LEAPS. Therefore, we
starting to analyze a synthetic position. If it's currently want to potentially target a Deltas around .80 to .90
January, then you might look to purchase call options in July whenever possible. This will give you the ability to replicate
or further out in November if you wanted. The further out you 80-90% of the stock move with a fraction of the cost
are buying the call option LEAPS, the more expensive the compared to purchasing the shares outright. Amazing right
options contract or premium will be, but the more time you
have to see the stock move favorably for you Sticking with the IWM example from earlier, let's look at a
LEAPS setup in an expiration seven months out from now, at
Once you identify the expiration month you are comfortable the time of this publication. The options pricing table for IWM
trading, you'll look for a deep ITM call option strike price to is shown on the following page for the call options which
purchase. Recall that any call option that is deep ITM will expire in March of next year. Notice how different the option
have a strike price that is lower than the current stock price. prices are for contracts this far out in time to what we've seen
The deeper ITM the call option strike price, the lower the earlier in this book
strike price from the current stock price, and the more the
option contract price will behave and trade as the underlying
shares would
Thankfully, we can use the option greek Delta to help us

estimate how reactive a particular call option strike price will
be to a $1 move in the underlying stock. A call option with a
Delta of .50 will behave as if you owned 50 shares of the
underlying stock. Your single call option still controls 100
shares of stock at expiration, but the day to day price
movement of the option contract moves as if you owned

.
option of just $2,092, which controls the same 100 shares.

That's an 87% discount on the cost of purchasing the shares.
As far as capital ef ciency is concerned, need we say more
Plus, there's another added bene t embedded here that we

haven't even discussed; black swan or crash risk. What if
IWM crashes? What if the stock goes down 20% this week
and trades at $137 for the next seven months? Does stock or
a long call option give you more protection
Your option contract has de ned and limited risk, whereas

the stock shares carry all of the downside risks of a market
crash. Trading the call option contract during this 20% drop
would only leave you exposed to a $2,092 loss, or the value
of the option contract, and nothing more. Holding long shares
of stock during a 20% drop would yield a loss of $3,440,
assuming IWM doesn't keep falling. Do you now understand
why trading and investing in the underlying stock is so
inef cient for investors? It's a poor vehicle for controlling and
managing risk
The $155 strike call options, which are well below the current With the deep ITM call option at the $155 strike price now
share price and considered deep ITM, are at an .80 Delta acting as our synthetic stock position, then the only
and are trading for $20.92. In real dollar terms, each call remaining step to complete our covered call strategy is to sell
option contract would cost $2,092 the front-month OTM call options above where IWM is
trading. Using the pricing table for the expiration 22 days
Now, let's pause here before we go any further and look at from today, we might look to sell the $176 strike for $1.38 per
the trade-off between buying the stock outright and buying contract. This additional premium reduces the cost basis on
this deep ITM call option. The cost of 100 shares of IWM the price of the deep ITM call option we purchased from
would be $17,200 vs. the cost to purchase a deep ITM call $20.92 to $19.54 overall. A 6.59% reduction in cost

fi
.
fi
fi
fi
.
Freeing up the additional capital with this one synthetic gives

you much more exibility to diversify your portfolio with other
covered call positions or hold cash in reserve. It always
fascinates us that more investors don't think about or use
options in this manner. The math and numbers certainly don't
lie. But that's why we're writing this book after all! To help
guide and education you on the choices available
Now, are you ready for an even better strategy than the one
presented above? Oh yes, I've been saving one of the best
for last. Enter the pure option seller
Synthetic Strategy #2: Short, Naked Put Option
The nal and absolute best synthetic alternative to a covered

call strategy, is to sell short put option contracts. Just
mentioning the idea of trading short, naked options strikes
fear into many traders as they are inherently associate it with
being high risk and foolish. On the contrary, we believe, and
the data supports, that stock ownership is high risk and
foolish
There you have it, a synthetic covered call position using Whatever prior connotations or beliefs you held about trading
LEAPS options with a fraction of the money invested and naked, unde ned risk or uncovered strategies, leave them at
signi cantly lower risk. And when expiration comes in 22 the door for a couple of minutes. We need you, and your
days, just re-sell another OTM call option in the next front- portfolio needs you to keep an open mind about this as we
month contracts while holding the same deep ITM call option walk through the setup. Once again, the numbers don't lie on
in the further out expiration month. Repeat these mechanics which strategy ultimately generates the best return metrics,
every month moving forward to maintain the synthetic and carries the least risk
position

fi
fi
.
fi
fl
.
Before we reveal the performance of selling short puts to strike price of the short call option. At that point, the stock
trading covered calls, let's discuss how and why this acts as gains are offset on a one to one ratio by the short call option
a synthetic alternative. To understand any synthetic strategy, you sold. This is the trade-off for executing a covered call
you need to understand the payoff diagram of the core, or strategy, limited upside potential beyond your strike price in
traditional, covered call options strategy shown again below. exchange for a higher probability of success overall by
collecting the option premium and reducing your cost basis
on the stock position
To create a viable synthetic position that mimics that of the

covered call strategy, we ideally need to nd an options
strategy that generates the same payoff line shown to the
left. If another strategy generates the same payoff line, then
we can use it as a reliable synthetic, assuming it has a better
risk and reward pro le
As it turns out, a short, naked put option creates precisely the

same payoff diagram as a traditional covered call. Upward
Long Stock sloping to the right, then levels off at some value
representing the same de ned pro t or limited upside
Profit
characteristics of a covered call strategy. Depending on the

Recall from previous chapters that a covered call strategy
Covered Call
strike price of your short put option contract, the payoff
purchases long stock and then sells an OTM call option diagram would be nearly identical to that of a covered call.
above the market price. The blending of the two components Crazy cool
creates the red payoff line shown; an upward sloping payoff
until the strike price of the short call option and then a at
Los
payoff line at any stock price above that level
It makes rational sense why the red covered call payoff Short line
Call
atlines or levels out Pric

Low Stock at stock prices
Highanywhere
Stock Price above the

fl
s
.
e
fi
.
fi
fi
fi
.
fl

Profit
Short Put
With this new synthetic starting to take shape, let's look at an

Los
example using the same IWM position we used earlier. To

collect as much premium as possible and mirror the payoff
diagram of the covered call, let's sell the at-the-money (ATM),
Low Stock Pric High Stock Price
or near ATM, short put options. The $172 strike price is
currently ATM, is quoted at $1.75 per contract, and expires
22 days from today "But Kirk, how can we sell something we don't even own
yet?" Great question, and it brings up some critical points.
To complete the synthetic trade, all you would do is sell this
First, you have to change gears mentally here a little and
single (one) put option contract and nothing else. Don't
now think about the impact of this short put option contract
purchase the underlying stock, don't buy deep ITM call
from both the buyer and seller perspective. Fire up the brain
options. Just become the option seller of the $172 strike put
cells from the Options Basics chapter about the rights and
contract. That’s it
obligations of options contracts as opposed to the traditional
stock investor's mindset of buying and selling shares

s
e
.
A put option buyer purchases the right, but not the obligation, traded lower because you collected the option premium as
to sell stock at the $172 strike price before or at expiration. an option seller
The put option buyer pays a premium, $1.75 in this example,
for this right to choose. If you are now the put option seller in At this point, it might seem like selling put options is too good
this example, you collect the $1.75 premium and have an to be true? You collect a nice option premium up front from
obligation to purchase stock from the option buyer at the the option buyer, and you don't need to own the stock.
$172 strike price if you are assigned on the contract. Easy so Effectively no money out of your pocket to initiate the
far and should make logical sense position; in fact, you're getting paid to initiate the trade, so
what's the catch? What could go wrong? Let's discuss this
Next up is the slightly confusing part, or at least until you
read the next couple pages. Since this is an uncovered or Understand rst that dummies do not run brokers and the
naked position, it means you are not required to own the options exchanges. You wouldn't lend money to someone
stock when you enter the trade. "Hold up Kirk, so what you knew had no means to repay the loan, would you? The
happens if I'm assigned and need to buy the shares from the same thing generally happens in the options market. The
put option buyer? brokers and exchanges fully understand the risk associated
with any position or options contract. They wouldn't let you
If you were assigned, you would purchase the shares from sell the single put option contract without making sure that
the put option buyer at the strike price of $172 per share. If you have enough capital to cover the risk should the position
you didn't want to hold the shares or continue to own the go wrong
stock, you could immediately sell the shares back in the open
market at whatever price the stock is trading at currently, say When someone decides to sell a naked, unde ned risk put
$171 per share. You have a net loss of $1 on the stock option contract, the brokers have to determine an effective
shares since you had to buy shares at $172 when they are way of mitigating the risk to approve the trade while also not
only worth $171. But you forget something important. When requiring you to purchase the stock. So how do they do this?
you account for the option premium you collected of $1.75 They calculate what is called a Margin Requirement
initially on the sale of the put option contract, your net pro t is You should think of Margin Requirements as really just a
$0.75 per contract, even after the assignment. Do you see fancy way of saying that you need to have "reserves" that are
what happened? You made money even when the stock set aside in your account to cover potential losses on your
short put option position. They don't take the money out of

.
fi
.
"
fi
.
fi
.
your account; instead, they earmark a speci c dollar value to ATM Short Put Performance (Fig. 3
the trade and reduce the remaining funds available for new
trades. The amount they will hold in margin depends on the At this point, we've talked at length about the capital bene ts
broker and your account type, but let's assume for simplicity of selling short put options. And while all of these ef ciency
it is roughly 20% of the value of the underlying shares plus points from a capital usage standpoint have merit, the real
the option premium collected question is, how does the short put option strategy compare
to the S&P 500? If a short put option performs worse than
Using our IWM example, if the stock is trading at $172 per directly buying and holding the market index, there's no point
share and you were to sell the $172 put option for $1.75 per in trading it
contract, the margin that would be required to execute this
trade would be $3,615. The stock price of $172 X 20% + Remember the research the CBOE did on the from earlier
$1.75 option premium. Again, this money is not taken out of chapters? Well, they also tested the performance of trading
your account but rather reduces your available funds for just a single short naked put option, referred to as the “Put-
trading to ensure that you have enough money to cover the Write Index” (PUT), and it generated nearly the same
risk of this position until it's closed or it expires annualized return with dramatically less risk and volatility in
the portfolio
If your brokerage account had a starting balance of $10,000,
your broker would earmark $3,615 for this short put option, If that wasn't enough, the put selling strategy also saw higher
which leaves you with $6,385 in available funds for other Sharpe, Sortino, and Alpha metrics than the S&P 500 and the
trading or investing activities Buy-Write Indexes that track covered call strategies. In Fig. 3
you’ll notice that the trajectory of the PUT strategy was both
NOTE: The gure referenced above is just the initial margin more stable and continued to outperform the market in most
that is required to enter the position. The on-going margin periods. Since the goal of the PUT strategy is market-like
requirements needed to cover the risk goes up and down performance with less volatility, we would expect the strategy
depending on the stock price, implied volatility, option pricing, to underperform slightly in bullish markets but outperform
etc. For this reason, we highly suggest you consider keeping dramatically in bearish markets. This is exactly what
short option contract trading, like short put options, to a happened and should continue to happen in the future. Plus,
minimum in your account and keep their position sizes small the more ef cient use of capital for a short put option frees
and manageable. As always, too much leverage can and will you up to diversify into a wider basket of underlying ticker
blow up your account if used incorrectly symbols

.
fi
.
fi
.
fi
.
fi
fi
Figure 3: Value of $1 Invested - CBOE Put-Write Index Return (PUT)
$30
$25
$20
$15
$10
$5
SPX BXMD BXM PUT

$0
1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Selling short put options generated an annualized return of No matter how you slice and dice it, option selling was a
9.54% per year with a standard deviation, or portfolio superior strategy when analyzing all facets of an investment
volatility, of just 9.90% vs. 14.90% for the S&P 500. The strategy. Short put options witnessed higher returns,
maximum drawdown was also much lower at -35.50% vs. dramatically lower risk and portfolio, with a fraction of the
-50.90%, respectively. That's a 33% reduction in portfolio capital exposure of long stock. Why was this the case
volatility and 15% more money during a market crash though
scenario
First, it might seem on the outside that the synthetic covered
call via the LEAPS offered a cheaper position cost-wise than

?
the short put option. And while that could be the case in selling, most investors associate them with having insanely
some contract months, the additional transaction costs and high risk and high volatility in their accounts because of what
structure of the LEAPS alternative was a drag on they have read online or heard on the news. But when you
performance look at the data, particularly from a third-party source like the
CBOE, the assumption that put option selling is risky is just
The LEAPS alternative required more transactions, at least not supported. If anything, it should be viewed as one of the
one to purchase the deep ITM call and another to sell the leading candidates for covered call synthetic strategies
OTM call in the front-month expiration, while the short put
option only requires one transaction. More transactions mean
more commissions paid to the broker, which drags down
performance. Additionally, since LEAPS are a combination of
options buying and options selling, the net effect of theta or
time decay on the position was slowed, leading to potentially
longer holding periods
Second, selling option premium has been proven, both by

our research as well as many others, to offer a reliable and
statistical edge over option buying strategies due to implied
volatility’s over-expectation of option pricing. When options
are priced, the implied volatility that market participants
expect in the stock’s future movement is overstated in both
directions long-term. People assume that stocks will move
higher or lower than they actually do. This creates a
mispricing in option premiums, similar to that of insurance
contracts, which bene ts those who are net option sellers
Conclusio
It has often been said that "People don't know what they
don't know." In the case of naked, unde ned risk option

n
fi
.
fi
.
Final Thoughts…
Congratulations on nishing this book
It's quite an accomplishment and one that many investors did not reach. I'd even
wager to say that just 10% or less of the people who started reading this book
made it to the end where you are now. You should be very proud of yourself
It's my sincere hope that this book was both an enlightening read as well as a
con dence boost in believing that you can, and are now potentially even
obligated based on the data, be able to beat the market performance with less
risk. It's not some mythical unicorn, but it does take a healthy dose of discipline
and consistency
Options trading presents one of the most exceptional nancial opportunities for
investors like you and me. I encourage you to use what you have learned in this
book as the foundation from which to keep pushing forward and exploring new
options strategies and new ways of generating income
Until next time, Happy Trading!

fi
.
fi
!
fi
.
Author
Kirk Du Plessi
Kirk is the founder and head trader at Option Alpha, which
offers an all-in-one platform for retail investors and traders.
Option Alpha is an industry leader in the options trading
space with rst class education, groundbreaking research,
integrated backtesting, as well as the rst end-to-end
automation technology for options trading strategies
Option Alpha and Kirk have been featured in dozens of publications

including Barron's, Smart Money, Forbes, Nasdaq, and MarketWatch. The
company was named to the #215 spot on the Inc. 500 in 2018 and the #723
spot on the Inc. 5000 in 2019
Kirk is a former Mergers and Acquisitions Investment Banking Analyst for

Deutsche Bank in New York, REIT Analyst for BB&T Capital Markets in
Washington D.C., and options strategy consultant for multiple funds, family
of ces, and nancial advisors. He holds a Bachelor’s degree in Finance from
the University of Virginia and lives in Pennsylvania with his wife and three
children.
fi
fi
fi
s
fi
.
Appendix & References
CBOE Option Strategy Indexes: http://www.cboe.com/products/strategy-benchmark-indexes
Options Basics Guide: https://www.optionseducation.org/strategies/all-strategies/covered-call-buy-write?prt=mx
TD Ameritrade Margin Handbook: https://www.tdameritrade.com/retail-en_us/resources/pdf/AMTD086.pdf
Pricing Table & Quote Screenshots: robinhood.com
Covered Calls Performance Research Report: https://optionalpha.com/covered-calls
Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options (ODD).
Copies of the ODD are available from your broker or from The Options Clearing Corporation, 125 S. Franklin Street, Suite 1200, Chicago, IL 60606. The information ins this book is provided
solely for general education and information purposes and therefore should not be considered complete, precise, or current. Many of the matters discussed are subject to detailed rules,
regulations, and statutory provisions which should be referred to for additional detail and are subject to changes that may not be re ected in the book information. No statement within the
book should be construed as a recommendation to buy or sell a security or to provide investment advice. Past performance is not a guarantee of future returns
The Cboe S&P 500 BuyWrite Index (BXMSM), Cboe S&P 500 2% OTM BuyWrite Index (BXYSM), Cboe S&P 500 95-110 Collar Index (CLLSM) and Cboe S&P 500 PutWrite Index
(PUTSM) and other Cboe benchmark indexes (the “Indexes”) are designed to represent proposed hypothetical buy-write strategies. Like many passive benchmarks, the Indexes do not take
into account signi cant factors such as transaction costs and taxes. Transaction costs and taxes for a buy-write strategy could be signi cantly higher than transaction costs for a passive
strategy of buying-and-holding stocks. Investors attempting to replicate the Indexes should discuss with their brokers possible timing and liquidity issues. Past performance does not
guarantee future results. These materials contain comparisons, assertions, and conclusions regarding the performance of indexes based on backtesting, i.e., calculations of how the
indexes might have performed in the past if they had existed. Backtested performance information is purely hypothetical and is provided in this document solely for informational purposes.
Back-tested performance does not represent actual performance and should not be interpreted as an indication of actual performance. The methodology of the Indexes is owned by Cboe
Exchange, Inc. Supporting documentation for statistics or other technical data is available by calling 1-888-OPTIONS, sending an e-mail to help@Cboe.com, or by visiting www.Cboe.com.
Cboe®, Cboe Volatility Index® Execute Success® and VIX® are registered trademarks and BXM, BXR, BXY, CLL, PUT, BXMD, CMBO, BFLY, CNDR, CLLZ and PPUT are service marks of
Cboe Exchange, Inc. Standard & Poor's®, S&P®, S&P 100®, S&P 500®, Standard & Poor's 500®, SPDR®, Standard & Poor's Depositary Receipts®, Standard & Poor's 500, 500,
Standard & Poor's 100, 100, Standard & Poor's SmallCap 600, S&P SmallCap 600, S&P 500 Dividend Index, Standard & Poor's Super Composite 1500, S&P Super Composite 1500,
Standard & Poor's 1500 and S&P 1500 are trade names or trademarks of Standard & Poor's Financial Services, LLC. Any products that have the S&P Index or Indexes as their underlying
interest are not sponsored, endorsed, sold or promoted by S&P OPCO LLC ("Standard & Poor's") or Cboe and neither Standard & Poor's nor Cboe make any representations or
recommendations concerning the advisability of investing in products that have S&P indexes as their underlying interests.
fi
fl
fi
.

Mastering Covered Calls (Option Alpha)

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Mastering Covered Calls (Option Alpha)

Uploaded by

Copyright:

Available Formats

Letter from Kirk

We are taught by traditional media, schooling, and decades of conditioning that

Chapter One Option Alpha © 2019. All Rights Reserved. 6 of 65

Chapter One Option Alpha © 2019. All Rights Reserved. 7 of 65

Chapter One Option Alpha © 2019. All Rights Reserved. 8 of 65

Chapter One Option Alpha © 2019. All Rights Reserved. 9 of 65

Chapter One Option Alpha © 2019. All Rights Reserved. 10 of 65

Chapter One Option Alpha © 2019. All Rights Reserved. 11 of 65

Chapter One Option Alpha © 2019. All Rights Reserved. 12 of 65

opens up the possibility to exit or adjust positions before Intrinsic Value

Chapter One Option Alpha © 2019. All Rights Reserved. 13 of 65

Chapter One Option Alpha © 2019. All Rights Reserved. 14 of 65

Chapter One Option Alpha © 2019. All Rights Reserved. 15 of 65

Chapter One Option Alpha © 2019. All Rights Reserved. 16 of 65

1) Delta The option's Vega is a measure of the impact of changes in

Deltas are always positive for call options and always

Chapter One Option Alpha © 2019. All Rights Reserved. 17 of 65

The last major greek is Theta. Theta is the decay of an

As expiration approaches, Theta speeds up, and the rate of

Alright - Whew! That was a lot of basics to cover, and

Chapter One Option Alpha © 2019. All Rights Reserved. 18 of 65

Chapter Two Option Alpha © 2019. All Rights Reserved. 21 of 65

Covered calls can be traded in practically any brokerage

The best way to think about a covered call, in our view, is as

your position now, but what if you could pre-sell shares at a

Chapter Two Option Alpha © 2019. All Rights Reserved. 22 of 65

Let's practice with a simple example

Chapter Two Option Alpha © 2019. All Rights Reserved. 23 of 65

Chapter Two Option Alpha © 2019. All Rights Reserved. 24 of 65

Chapter Two Option Alpha © 2019. All Rights Reserved. 25 of 65

Chapter Two Option Alpha © 2019. All Rights Reserved. 26 of 65

Chapter Two Option Alpha © 2019. All Rights Reserved. 27 of 65

covered call setups. Does this mean covered calls won’t

We wrapped all the research and analysis up for you in a

Chapter Two Option Alpha © 2019. All Rights Reserved. 28 of 65

Chapter Thre Option Alpha © 2019. All Rights Reserved. 30 of 65

Chapter Thre Option Alpha © 2019. All Rights Reserved. 31 of 65

For clarity, each strike price doesn't need to have precisely

Chapter Thre Option Alpha © 2019. All Rights Reserved. 32 of 65

Admittedly, it’s not as bad as GOOD on the previous page,

Chapter Thre Option Alpha © 2019. All Rights Reserved. 33 of 65

Filters for fundamental or technical analysis could have been

Now, you're a pretty smart person if you're reading this book,

Factor #2 - Fundamental or Technical Analysis Filter • Forward P/E rati

• Price to Free Cash Flo

Chapter Thre Option Alpha © 2019. All Rights Reserved. 34 of 65

Chapter Thre Option Alpha © 2019. All Rights Reserved. 35 of 65

Chapter Thre Option Alpha © 2019. All Rights Reserved. 36 of 65

Longer-dated (back-month) options contracts erode at a

Chapter Thre Option Alpha © 2019. All Rights Reserved. 37 of 65

Keep in mind at this stage that since we are selling call

Chapter Thre Option Alpha © 2019. All Rights Reserved. 38 of 65

ATM Covered Call Performance (Fig. 2

Chapter Thre Option Alpha © 2019. All Rights Reserved. 39 of 65

SPX BXMD BXM

Chapter Thre Option Alpha © 2019. All Rights Reserved. 40 of 65

If you sell the front-month options, you will collect a lower

Chapter Thre Option Alpha © 2019. All Rights Reserved. 41 of 65

If you've followed the rst three steps outlined in this chapter,

Chapter Thre Option Alpha © 2019. All Rights Reserved. 42 of 65

Stocks do move down from time to time - shocking right. So,

First, don't worry; we wouldn't have carried you this far to

Chapter Fou Option Alpha © 2019. All Rights Reserved. 44 of 65