Friday, November 17, 2006

A Bit of History

I started this covered call portfolio in May 2005. In the beginning I sold front month options with the goal of making 2-3% return per month. I didn't pay much attention to fundamentals, at that time, except for Altman's Z-score, which measures the likelihood of a company going bankrupt. I also didn't use a value investing approach. As such, some of the stocks I purchased were overvalued from a value investing standpoint.

In March 2006, after hearing about Systematic Covered Writing, which teaches a covered call methodology, I switched from selling front month options to longer term options, mostly ITM, returning 12%+ cash back and 24% annualized if called. This brought in more income in April and pushed out the expiration dates by about 3 months or more. So, rather than bringing in 2% in April, I brought in 6%, or about 3 months worth of income in a single month. This meant that I could bring in zero income for the next 2 months and still have an average income of 2% per month. It also meant less trading each month.

During May-July the market declined and many of my positions were underwater. I went on vacation the entire month of June and never checked my portfolio. When I returned, a few stocks were called away and I had cash to invest in new positions. However, since several positions were down I needed to use some of the money to recover them by dollar cost averaging.

May 2006 completed 1 year of trading covered calls and, when I returned from vacation in July, I reviewed my trading plan. Although I had met my goals I was concerned about the number of positions that were down. I modified my stock selection criteria to concentrate more on fundamental analysis and use a value investing approach, with the goal of reducing the risk of a major stock decline or company bankruptcy. It's too early to tell what difference this has made since I've only added a couple of new positions since making this change.

I only trade about once a month, during the week of or following option expiration. Each month I replace any stocks that are called away and make adjustments to existing positions. Starting next week, I'll post any new positions I establish and update them through closure.