Alternate Covered Call – Covered call write on your long ITM calls

Sometimes you end up a situation where you were bullish on a stock and you buy some long calls on it and the stop just ends up in a whipsaw range-bound price action. Take YELP for example

YELP had hit $58 (I bought puts here and sold them at $51). Then, when I noticed the euphoria had clearly died and the imminent pullback had happened,  I bought naked calls at $48. The only thing I didn’t know was that for the next 20 days YELP wanted to “play dead” like my dog Max. The stock refused to budge. I was losing precious Theta on my long positions everyday.

Most option newbies are familar with covered call writes. They own a stock and they sell some OTM covered calls against it.

Did you know you can do the same for ITM calls too. When a call is deep in the money, it’s delta is very near to 1. This means it behaves exactly like “real stock”. You can start selling OTM calls against your long position and collect theta and possibly keep the whole premium if the options don’t reach the OTM strikes you sold. Isn’t this great?????? The best thing about this strategy is, IT TIES UP $0 ADDITIONAL CAPITAL. It is almost like free money!!

But there is always a catch; isn’t there? The catch is if the stock moves up, your gains will be muted because the OTM calls you sold will gain value and reduce the profits you can get from the naked calls. But this is short-term if the stock expires below the OTM strikes, then you strike GOLD, so to say. If it blows through your strike, then you cap out your gains and simply close out your position as 1 spread.

Easy money from irrational exuberance – YELP!!

I cannot tell you how many times these trades work for me. I love them. Basically, stay away from earnings plays (because of the outliars like FB, BIDU etc + inflated vol before earnings). What you do is wait like a Python after earnings. You do need to do some research about the stock though so that you know if the post-earnings move is justified or not.

If the post-earnings move is way way out of the expected move that the options were implying, then it becomes a potential trade for you. Case in point YELP. It shot up $22% in 1 day even after the company reported a loss (the loss was less than what analysts expected. Ha!). I was ok till this point, but then the comedian Cramer says in CNBC that AAPL should buy YELP for $75. The stock shot up another 10% in 1 day. This was a clear red flag for me. Whereas people were buying it left and right and saying that it will be $65 next week and even $100 in a month, all I had to do was wait till it hit the top of its ‘extended range’ and buy some PUTS. Now, when a stock is so obviously overbought/oversold, I don’t trade spreads; I just go long an option naked!!

With Yelp, the stock dropped from almost $59 to $52 in 1 day and it is going down as I speak. Bottomline, the cliche “be greedy when others are fearful and be fearful when others are greedy” is TRUE !

These opportunities don’t arise every day, but believe me they arise often and guess who gets to go the bank laughing? YOU!!