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Covered-Calls 101

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Position Management - Part II

The covered-call strategy works well with a variety of financial instruments in all but the most bearish market cycles. In addition, selling covered-calls is also one of the safest ways to learn about option trading and that was the intention when we began this new educational series. However, the issue we selected (NASD: CALM) for the first narrative has moved sharply higher in the past few days so it may not provide any opportunity for position management in the near future.

With that fact in mind, we are going to choose a new covered-call candidate from this week's long-term CCS portfolio and track it for possible adjustments. The underlying stock is Calgon Carbon (NYSE:CCC) and while the overall position is less conservative (than CALM), the additional time until expiration offers greater potential for volatility thus it is more likely to require an early-exit trade or adjustment.

Although we are not going to recommend a specific number of shares to purchase, a minimum amount (such as 300-500) is generally necessary to effectively offset commission costs and the number you choose should always be appropriate with regard to the size/value of your investment portfolio.

The position specifics are as follows:

Buy CCC Stock: Last Price = $18.45
Sell APR-17.50 Call (CCC-DW): Bid Price = $2.00
Cost Basis = $18.45 - $2.00 = $16.45
Downside Protection = 10.8%
Maximum Profit = 6.4% (without margin)

Our net-debit target for the buy-write order (Buy CCC stock/Write CCC-DW options) will be $16.25, which is slightly below the cost basis listed above. If this entry price is achieved, the maximum profit will be 7.6% and the downside break-even point will be 11.9% below the current cost of the stock.

We won't be making any actual trades but we will track the price activity of CCC during the next few sessions to determine if the buy-write order could (likely) have been filled. Once this occurs, we'll establish our initial stop-loss point (between $15-16) and discuss how to manage the position to limit potential losses.

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