Covered Calls are a powerful tool and strategy to boost earnings. I've heard of using this some time ago, but after looking into it realized there are many factors to consider:
1) Commission costs.
2) What if shares go down below cost?
3) What strike price?
4) What expiry date?
5) What companies/stocks to purchase?
Here's how I'm playing the Covered Call writing strategy. I have been accumulating shares in several larger dividend companies in order to write Covered Calls on them. As per most who follow this strategy the goal is to enhance returns by extracting premiums and create a certain discipline for selling/refreshing my stocks every now and then.
However, to maintain a position for my long term goal of dividend income generating portfolio I maintain synthetic Dividend ReinvestmentPlans and will allot a portion of the shares for writing.
So far I've built up positions in BNS, CWB, MFC, and SLF for writing. I still don't feel they are large enough to more efficiently generate Premiums. As you'll see, below are my target number of contracts to write. This builds in an initial Call writing and if the Premium increases; provides flexibility to average into the Premium.
Positions:
| Stock | Avg Cost | Current Price | # of Shares | Target # of Contracts |
| BNS | $57.05 | $57.95 | 500 | 2-3 |
| CWB | $26.04 | $23.56 | 600 | 2 |
| MFC | $19.92 | $21.24 | 1000 | 4 |
| SLF | $40.78 | $44.07 | 600 | 2 |
1) Commission Costs.
I use both Questrade and BMO InvestorLine; and for Option trading the commissions are fairly similar, but BMO IL's charges $0.25 more per contract.
Taking Questrade as an example here's how it looks like:
Option Commission: $9.95
Option Cost Per Contract: $1.00
If I write/buy 2 Contracts that means I pay $11.95 ($9.95 Option Commission + 2 Contracts x $1.00).
The biggest difference is with Option assignment.
Questrade is more competitive by far, charging a flat $24.95.
BMO IL has a minimum $43 + laddered contract cost depending on the Option price, starting at $1.50 per Contract.
https://www.bmoinvestorline.com/selfDirected/pdfs/FeeSchedule_EN_May.pdf
Regardless of stocks or options the Commissions can have a significant impact on your profits/losses/break evens.
Example:
On December 21, 2015 I wrote a single Call option on CWB (160415C26.00):
| Date | Symbol | Type | Expiry | Strike | Quantity | Price | Gross | Commission | Net Price | Net Amount | Exposure | Status | Type |
| 2015-12-21 | CWB | Call | 04/15/16 | 26 | 1 | $0.7000 | $70.0000 | $10.95 | $0.5905 | $59.05 | $0.00 | Open | Covered |
Strike: $26.00
Expiry: April 15, 2016
Premium: $0.70 ($0.70 x 100 = $70)
Commission: $9.95 + $1 = $10.95
Net Premium: $70-$10.95=$59.05
This means in 4 months if the share price appreciates to $26 or higher 100 shares of my CWB will be sold to the Call contract owner. This means I sold insurance to another investor for roughly $14.76 per month. In addition I will receive an additional dividend payment of $23 on the 100 shares before contract expiry since ex-dividend is approximately March 16-19.
The heaviest commission will be with the potential assignment. At $24.95 commissions will eat up 42.2523% of the profits, leaving me with $34.10. Looking at it another way I basically sold for $0.3410 per share over $26. $26.341 Assignment Price - $26.04 Average Cost = net profit of $30.10.
If there is no assignment then I'll get to keep the $59.05 and I can continue writing.
Here's where not selling the full number of contracts comes in; if the share price rises closer to $26 then the Premium will increase as well. I can wait until the shares come close to $26 (or higher) and average in by writing a second Call for a higher Premium. If the shares fluctuate and decline afterwards I then have a choice of Buying to Close (BTC) the position.
2) Going underwater on my investment.
This is tough as my CWB example shows my average cost is $26.03, but share price is at $23.56. Holding for the long term I have a combination of choices. a) write a put to accumulate more shares via assignment and/or try to gather more premiums, and b) wait for a fluctuation in the price and write a Call closer to my break even.
Instead of writing a new Put due to existing exposure; I opted to write a Call as the share price bounced from lows to $23's.
3) Choosing Strike Price
This depends on the current stock price. Targeting higher Strikes Out of the Money will garner a smaller premium. Closer to share price gives a better premium.
4) Expiry Date
This also factors into the Premium. Further out gives you higher Premium.
5) Company/Stock Types?
I want dividend type stocks to achieve long term income goals. So, the safest is to target these stocks.
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