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Make money on your losers

How one savvy woman generates income on her losing stocks—by selling covered calls.

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When you think of an options trader, do you imagine a young man surrounded by chart-filled computer screens day trading?

Then meet Mary Jo Anzel, a Long Island retiree who easily dispels that stereotype. We caught up with Mary Jo recently as she was heading off to celebrate her granddaughter Carly Jayne’s 10th birthday, armed with a dozen cupcakes and sprinkles. What Carly Jayne doesn’t know yet is her grandmother’s plan to share something even more valuable: her love of investing—specifically, writing covered calls.

“At the birthday party, I tell her: 'You see that bottle of Pepsi (PEP)—you own a part of that company.' And if we stop at a Bank of America (BAC) after the party, I’ll say, ‘You know, Carly Jayne, you own a piece of this bank, too,'” says Mary Jo.

Of course, Carly Jayne is not yet ready to do her own investing, let alone options trading, but all in good time. Indeed, Mary Jo recently stopped by a Fidelity branch to enable Carly Jayne’s trust, which she manages, for options trading. Soon after, she wrote her first call on that account. “I’m really a buy-and-hold investor, but it was still exciting to see that I made her $200 on calls of a big tech company, while we slept!” says Mary Jo.

Retired from work, but not from investing

A note on early assignment

Sellers of covered calls must consider the risk of early assignment (i.e., the option is exercised by the buyer before it expires) and when the risk is greatest. Early assignment of stock options is generally related to dividends, and sold calls that are assigned early are generally assigned on the day before the ex-dividend date. In-the-money calls whose time value is less than the dividend have a high likelihood of being assigned early.

Mary Jo grew into full-time investing after retiring as a director of labs at a New York Blood Center. A scientist by training, she has many interests, including teaching watercolor painting and playing chess. But her passion is investing, and her favorite strategy is writing covered calls. “At heart, I am a long-term investor,” she says. “But everyone makes mistakes. You invest in a great company but the stock can go to hell in a hand basket. What do you do then? If you don’t want to sell, or at least you don’t want to take a big loss, that’s where writing covered calls can come in.”

At first, Mary Jo said she thought options were too risky, and too complicated. Then, she recalls, one of her friends with whom she plays chess asked her, “What if you could lose less on a losing stock? Would you do that?”

Mary Jo decided to give the strategy a try, so she wrote (i.e., sold) three covered call contracts on 300 shares (one contract covers 100 shares) of a homebuilder when the stock was trading at $21, for a 50¢ premium on each contract. The options expired unexercised and she got to pocket the $150 (three contracts x 50¢ each contract x 100 shares underlying each contract).

She couldn’t believe at first that the options weren’t exercised. “I like to think of that trade as a dog with fleas that turned into a healthy Irish Setter. So I did it again, this time at 45 cents. Again, they weren’t exercised. So I did it again, and again.” Ultimately, the stock was called away (i.e., exercised by the buyer), but the premium income she generated on all those sold calls wiped out her loss on the stock and turned it into a profitable trade.

“Can I really do this?” she recalls asking a Fidelity rep. “‘Absolutely. The covered call strategy helps manage risk, and lots of people do it,’ he told me. I couldn’t believe it! We still laugh about it.”

Mary Jo's strategy

Since then, Mary Jo has become a seasoned practitioner of the art of covered calls. Her strategy focuses on buying large cap stocks, some to hold for the long term, others as part of her covered call writing strategy. Mary Jo has what she considers her “sleep at night” large caps. “These are companies I buy and hold, and I don’t write calls on them. I go to sleep every night thinking I’ll get a full dividend. And if something adverse happens and the price drops, I consider buying more.”

Then she has other companies that she buys to trade, sometimes just before earnings announcements, when the stock can be volatile and call premiums can spike. For example, at one point she owned Hewlett-Packard stock in her own portfolio and sold the $34 call for a premium of 52¢ in advance of the company’s second quarter earnings announcement on May 22, 2014. She also bought the stock in her IRA as well as Carly Jayne’s account on May 21 at $33 and then sold in-the-money (i.e., an option that has intrinsic value and may be worth exercising) calls for 91¢. The stock fell sharply when earnings were released early before the closing bell on May 22, so her calls were not exercised before the expiration date, and she and Carly Jayne pocketed nice premiums.

Moreover, the morning after the earnings announcement, H-P CEO Meg Whitman allayed some of the fears sparked by the earnings results, so the H-P stock that Mary Jo owned stabilized. “In a week or so, I expected to get a dividend on the stock, and then I might have written some calls again,” she says.

How the covered call strategy works

Let’s say you already own 100 shares of a stock that is trading at $30 a share. Assume that you don’t think it will go up over the next several months, but you do not want to sell the stock and would like to generate some additional income on the position. This is a case where a covered call strategy may work well.

If you sold one call option, you would effectively be agreeing to sell 100 shares of the stock at an agreed-upon price, known as the strike price, if the option is exercised. You would earn upfront income for selling the option. But in doing so, you would forgo potential profits if the stock price rose and the calls were exercised. In this event, you would have to sell the stock at the strike price. So, you would need to be comfortable with that tradeoff.

Managing risk

Of course, there is risk to any stock market strategy, not to mention trading costs as well (though they are only $7.95 per equity transaction at Fidelity, plus $0.75 per option contract traded).

Mary Jo tries to minimize her risks by focusing on large, established companies that have strong trading liquidity and relatively low business risk. “I love companies that I don't think are going out of business. If the stock is doing well, I hold on and collect the dividends. If it is not, I write covered calls to try and generate income. Generally, I feel these stocks will eventually come back after any pullback, because when they get to a certain point, I think the value buyers swoop in and push the price back up.”

Be aware that the strike price you choose determines how much premium you receive for selling the option. With covered calls, for a given stock, the higher the strike price is from the stock price, the less valuable the premium. Consequently, when choosing a strike price to write a covered call at, you should weigh the income (premium) you are hoping to receive against the probability that the option may be exercised.

Also, Mary Jo avoids some other option strategies that can involve more risk. With covered calls, the downside is limited to the loss on the underlying stock minus the premium you receive. By contrast, if you write calls on stocks you don’t own—these are known as “naked” calls—your losses can be much greater. “I keep it simple,” says Mary Jo. “I never do anything naked, no pun intended.”

Finally, she is careful to minimize taxes as she manages her accounts and Carly Jayne’s. Because the income she makes on her call premiums is taxed as ordinary income, she is careful to try and offset those gains with any losses from the sale of her losers. “It takes some of the pain out by potentially paying less in taxes,” she explains. In her granddaughter’s account, she tries to offset gains with losses to keep Carly Jayne’s taxable income below $2,000 a year. This way, her granddaughter pays taxes at the lower “kiddie tax” rate, as Mary Jo calls it, rather than at her parents’ higher tax rate. That’s one savvy lady.

Clearly, traders come in very different shapes and sizes. And in Mary Jo and Carly Jayne’s case, they may yet come in different generations.

Learn more

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Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Prior to trading options, you must receive from Fidelity Investments a copy of "Characteristics and Risks of Standardized Options" by clicking on the hyperlink, and calling 1-800-FIDELITY to be approved for options trading. Supporting documentation for any claims, if appropriate, will be furnished upon request.
The experience of this customer may not be representative of the experiences of all customers and is not indicative of future success.
Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments.
Past performance is no guarantee of future results.
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