PREFACE
While covered calls are one of the most commonly used option strategies, it turns out we need to be clever in how we treat earnings in order to maximize the strategy in Amgen Inc (NASDAQ:AMGN) . Even further, if we don't do this analysis, we can easily dismiss some worthy covered calls opportunities as losers. This is the case we find right now.
STORY
It turns out there's a lot less 'luck' involved in successful option trading than many people realize and we're going to review that right now for AMGN. Let's first examine a two-year back-test of a covered call strategy with some simple rules:
* Trade monthly options (roll the trade every 30-days).
* Avoid earnings
* Test this strategy for two-full years
Here's how this quick set up looks in the back-tester:
If we do this test, it turns out the best covered call to sell is out of the money with a delta of 35. If the term delta is unfamiliar to you, we have cover at the end, but suffice it to say any delta below 50 is usually out of the money and certainly a 35 delta is out of the money.
RESULTS
If we do a covered call in Amgen Inc (NASDAQ:AMGN) , but always skip earnings we get these results:
| Buy AMGN Stock, Sell 35 Delta Call |
| * Trade Frequency: 30 Days |
| * Always Avoid Earnings |
|
| Gross Gain: |
$12,530 |
| Gross Loss: |
-$10,516 |
| Covered Call Return: |
12.5% |
| Stock Return: |
-3.7% |
|
| Out-performance: |
16.2% |
That tile tells us two critical pieces of information. First, we see a very nice covered call result with a 12.5% return. But, just as important, we also see that the 12.5% return in the covered call considerably out-performs Amgen Inc stock over the last two-years, which hit -3.7%.
In total we're looking at a 16.2% out-performance while taking less risk than owning the stock outright and always avoiding earnings risk.
GOING FURTHER
While out-performing the stock and avoiding the risk of earnings is a powerful implementation of a covered call, we actually did even better. Next we do the same back-test, but this time we only trade earnings. That is, we open our position two-days before earnings, let the event occur, and close the position two-days after earnings.
Here's the set-up -- very easy. Just click the appropriate buttons.:
Now we examine the results for that same 35 delta covered call.
| Buy AMGN Stock, Sell 35 Delta Call |
| * Trade Frequency: 30 Days |
| * Only Trade Earnings |
|
| Gross Gain: |
$2,005 |
| Gross Loss: |
-$2,865 |
| Covered Call Return: |
-5.1% |
Now we see why avoiding earnings was so powerful. Holding the covered call in Amgen Inc (NASDAQ:AMGN) through earnings under-performed the stock and certainly under-performed a covered call that avoided this risk. In fact, our strategy to avoid earnings beat the strategy held only during earnings by a whopping 17.6%. It could have been so easy to miss this result without diving just a little deeper than the standard option analysis.
TRADING TRUTHS
Going through this practice with Amgen Inc (NASDAQ:AMGN) reveals that the whole idea of a 'options expert' has been made made overly complicated. Below, we go the final step (with a video).
WHY THIS MATTERS
When we wrote that there's actually a lot less 'luck' and a lot more planning in successful option trading than many people know, this is what we meant.
It's not about trying to guess which stocks will go up or down.
What the back-tester allows us to do is find calm, low stress stocks or ETFs (like SPY, QQQ, etc), and in this case, Nike, and find the option strategies that have created a high percentage of winning trades, gaining profitability slowly, while avoiding unnecessary risks - specifically, avoiding earnings.
In a five minute video, your entire view of the options world and what people mean when they say 'expert trader' will be turned upside down - to your advantage.
Tap here to see the CML Pro option back-tester.
Thanks for reading, friends.
Risk Disclosure
Trading futures and options involves the risk of loss. Please consider carefully whether futures or options are appropriate to your financial situation. Only risk capital should be used when trading futures or options. Investors could lose more than their initial investment.
Past results are not necessarily indicative of future results. The risk of loss in trading can be substantial, carefully consider the inherent risks of such an investment in light of your financial condition.
