You talk about selling calls on long-term positions and then buying them back. How does that work? Right now I have 200 shares of JDSU. As you have noted the stock has been weak of late. There is an analyst meeting on 9/12, which I hope will boost the stock. I am willing to sell some December 135's. If the stock were to go down can I buy these back for a profit? If so do I sell to open or close, and then conversely buy to open or close. If the stock goes up I am happy with selling the stock at $135. So, is this a way to hedge my position. (September 11, 2000)

  As we alluded to in the summary, we have been selling calls on our long term holdings as the market started to pull back once again. This invariably happens, so it is good to know how to make money on the stocks you currently hold and want to hang onto when they do pull back.

We cover this in detail on the Q&A section at the website. Go to the Q&A section in the members section and search for 'covered calls' by hitting control 'f'. That takes you to several pages where we have discussed selling covered calls in past issues.

As to some of your specific points, you have the right idea going in. We like to sell when the market starts to turn, but we usually like to sell closer in, the current month, if we can. That way we can play it each month if possible, but that is no requirement. We sold some October calls last week and were buying them back today for a nice profit. Indeed, because we could not get decent premiums we went out to October. As we did not plan on riding them down to zero, we knew we could sell the Octobers and get a good net when the stocks started to fall.

We usually sell at or slightly out of the money, but we will sell slightly in the money if we feel the stock is going to sell down pretty fast. That way we get more movement on the options, and we get more premium by selling slightly in the money. Near term options that are at the money are the most volatile options, and you can get the greatest move when the stock falls. We sell the options to open a covered position. We calculate where we will buy them back going into the transaction. We try to do this at least once a month, and we do not want to lose our stock, so we know where we want to buy them back going in. We set our buyback point with our broker when we place the order to sell and make it contingent on the sale.

We calculate the buy point by determining where support is. We subtract the current price from the support price, and multiply that by the delta. That tells us how much our option should fall in value if the stock falls to that level. We then set our buyback at that price. That part of the transaction is the 'buyback to close position.'

This is a bit different from just saying 'I am willing to sell at this point' and selling the calls at that strike price. We love doing this in our retirement accounts (but we do it in our regular accounts as well) because it is a good cash generator. We have repeatedly sold calls on some of our stocks as they sell down $14 or so per day. Sell them, buy them back automatically, then sell the next strike or two down. When a stock is at $200 or more and we feel the leader will be right back up, we are comfortable hanging onto it as long as it continues to perform as a leader. We get cash in the account, and it lowers our cost basis on the stock we have. And if it is in one of our retirement accounts, it all builds up tax free.

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