Friday, October 22, 2010

Covered Calls and Cash Secured Puts on the Same Stock

Someone posted the following comment yesterday.

"Is there anything bad about selling CC and CSP for the same stock, at the same time?"

Here's my response:

There's nothing wrong with selling a Covered Call (CC) and Cash Secured Put (CSP) on the same stock, at the same time. Two caveats though 1) you should want to own the stock at both prices and 2) you should be careful not to exceed your asset allocation for a given stock. You can think of selling a CSP as a way to average down if the stock declines. But, as always, the key is company selection. Make sure you only sell CC's and CSP's on companies you'd be happy to own for the long term.

Here's how I use CC's and CSP's.

If the stock is priced at or below my target price, which is anywhere from 20-50% below Morningstar fair value estimate, I'll buy the stock and sell an OTM call (CC). I'll also look to sell a CSP further below my purchase price if I can get a return greater than the yield on 10 Year US Treasuries.

If the stock is priced above my target price, I'll sell a CSP near my target price. If assigned on the CSP I'll sell an OTM call (CC), and look to sell another CSP below my purchase price as above.

I currently have 13 CC's and have sold CSP's on 8 of them, and I have 12 CSP's with no CC position (33 positions in total). I manage each position separately even if assigned on the CSP.

I've added the following data to all of the positions I post here, including new positions and adjustments. I updated all the trade positions I did this week to include this data.

  • Dividend Champions Status =
  • Years of Consecutive Dividend Increases =
  • Years of Positive Free Cash Flow (last 10 years) =
  • Discount to Morningstar's Fair Value Estimate =

The discount to M* fair value is calculated against my cost basis (i.e. purchase price or CSP strike), not the current stock price.

For example, here's the data for the Monsanto CSP I established yesterday.

  • Dividend Champions Status = Contender

  • Years of Consecutive Dividend Increases = 10
  • Years of Positive Free Cash Flow (last 10 years) = 9
  • Discount to Morningstar's Fair Value Estimate = 29.58%

My target buy price is 30% below M* fair value, so I sold a Jan 50 Put, which is close to my target buy price.

If assigned in Jan I'll look to sell a 50 or higher Call, and sell a 45 or lower CSP.

This is the method I developed while on vacation for 5 weeks back in June and I've been using it ever since with good success. Since I'm limiting all of my positions to solid dividend paying companies I also sleep better at night with his strategy.