A Paper Trade Experiment

One of my readers posted the following comment:

"Let's do an experiment--Let's compare your actual results on these 2 transactions with what your results would have been if you sold the August calls first and then at Aug expiration date sold the Sep."

I thought this would be an interesting experiment, even though I'm pretty sure that the front month calls will provide a much better return, in most cases. However, returns are just part of the picture. The other is risk (i.e. downside protection). I evaluate both sides and don't base my decisions strictly on returns or on risk. It's a balancing act between risk/reward and everyone will have a different tipping point. So, although some will prefer to maximize returns, others prefer to minimize risk, and still others prefer something in the middle.

I posted my original positions below, along with 2 paper trades for each stock. Since the prices have moved since I established my positions I thought it would be best to show 2 new positions for Aug & Sep at current prices as of Friday's close. These will be slightly different from my original positions but will give you a better reference point.

EBAY - Original Position

27-Jul-07 - Initial Stock Position - BTO 100 EBAY @ 32.95
27-Jul-07 - Initial Call Option - STO 1 Sep07 32.50 Call @ 1.84

Stock Investment: $3,294.50
Income Generated: $184.00
Percent Income Generated: 5.59%
Annualized Income Generated: 36.40%
Net Profit If Called: $139.50
Percent Return If Called: 4.23%
Annualized Return If Called: 27.60%
Days to Expiration: 56 days

EBAY - Paper Trades

27-Jul-07 - Initial Stock Position - BTO 100 EBAY @ 32.58
27-Jul-07 - Initial Call Option - STO 1 Aug07 32.50 Call @ 0.94

Stock Investment: $3,258.00
Income Generated: $94.00
Percent Income Generated: 2.89%
Annualized Income Generated: 50.15%
Net Profit If Called: $86.00
Percent Return If Called: 2.64%
Annualized Return If Called: 45.88%
Days to Expiration: 21 days

27-Jul-07 - Initial Stock Position - BTO 100 EBAY @ 32.58
27-Jul-07 - Initial Call Option - STO 1 Sep07 32.50 Call @ 1.64

Stock Investment: $3,258.00
Income Generated: $164.00
Percent Income Generated: 5.03%
Annualized Income Generated: 32.81%
Net Profit If Called: $156.00
Percent Return If Called: 4.79%
Annualized Return If Called: 31.21%
Days to Expiration: 56 days

WLL - Original Position

27-Jul-07 - Initial Stock Position - BTO 100 WLL @ 41.02
27-Jul-07 - Initial Call Option - STO 1 Sep07 40.00 Call @ 2.99

Stock Investment: $4,102.00
Income Generated: $299.00
Percent Income Generated: 7.29%
Annualized Income Generated: 47.51%
Net Profit If Called: $197.00
Percent Return If Called: 4.80%
Annualized Return If Called: 31.30%
Days to Expiration: 56 days

WLL - Paper Trades

27-Jul-07 - Initial Stock Position - BTO 100 WLL @ 41.64
27-Jul-07 - Initial Call Option - STO 1 Aug07 40.00 Call @ 2.34

Stock Investment: $4,164.00
Income Generated: $234.00
Percent Income Generated: 5.62%
Annualized Income Generated: 97.67%
Net Profit If Called: $70.00
Percent Return If Called: 1.68%
Annualized Return If Called: 29.22%
Days to Expiration: 21 days

27-Jul-07 - Initial Stock Position - BTO 100 WLL @ 41.64
27-Jul-07 - Initial Call Option - STO 1 Sep07 40.00 Call @ 3.29

Stock Investment: $4,164.00
Income Generated: $329.00
Percent Income Generated: 7.90%
Annualized Income Generated: 51.50%
Net Profit If Called: $165.00
Percent Return If Called: 3.96%
Annualized Return If Called: 25.83%
Days to Expiration: 56 days

So, as you can see the Aug CC's provide higher annualized returns and the Sep CC's provide more downside protection (Percent Income Generated). Either choice provides good returns so it comes down to how much downside protection you feel more comfortable with.

I'll monitor these paper trades and post any adjustments if the Aug calls expire. If they get called away then I'll continue to post updates on my "real" positions and provide a comparison when they eventually get called away.