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One vs. Two Month Expirations: Which Is Better?
12/05/2013 8:00 am EST
Option expert Alan Ellman of TheBlueCollarInvestor.com investigates whether it’s more profitable to use options with one-month expirations vs. two-month expirations in a covered call strategy.
Two of the cornerstones of the BCI methodology for covered call writing involve selling options with one-month expirations and avoiding earnings reports. Several of our astute members have inquired about selling two-month options instead. The rationale is that all stocks and ETFs have options for the current and next month. The months farther out will vary depending on the cycle that the security was randomly assigned. The proposed strategy is set up as follows:
After an earnings report passes, we can sell a two-month option on that stock and therefore require less management time and commissions. Once the report passes, if we still like the stock, we then sell another two-month expiration and so our portfolio turnover will decrease. At first glance this appears to be a reasonable approach that should be investigated.
No one can dispute that commissions will be lower, probably cut in half. But if we use an online discount broker, these fees will be negligible especially if we are trading multiple contracts per security. Position management will be the same with the exception that rolling an option will not be necessary should the strike be in-the-money after the first month. So far, all other factors being equal, the strategy appears to be viable. However, let’s not forget the most important aspect of covered call writing and that is generating the levels of option premiums and profit and maintain our low-risk posture. In this article, I have selected a stock from our Premium Watch List, Opentable Inc. (OPEN), and will evaluate the one- and two-month returns. I am writing this article on November 18, the start of the December 2013 contracts. Here is the options chain for the one-month December expirations:
With the stock trading @ $86.16, the out-of-the-money one-month $87.50 call options are trading @ $3.
Next, let’s view the January, two-month options chain:
The two-month January, 2014 $87.50 out-of-the-money call options generate $4.50. To compare “apples to apples” we must annualize these returns and then compare.
December, one-month options annualized:
$300/$8616 = 3.48% = 41.8% annualized
January, two-month options annualized:
($450/2)/$8616 = 2.6% = 31.3% annualized
The annualized returns are 10% greater for the one-month expirations than for the two-month expirations.
Two-month expirations will reduce trading commissions and portfolio turnover. However, these benefits will dwarf in comparison to the financial benefit of selling one-month options.
By Alan Ellman of TheBlueCollarInvestor.com
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