Calculating Covered Call Returns

Calculating covered call returns can be tedious. Do you use the bid or the ask price for the stock? What

about the option? Should you include any dividends if there is an ex-dividend date prior to option

expiration? A modern covered call calculator will handle this for you. It will most likely assume you are

doing a buy-write (buy the stock and write the call option), and therefore use the stock ask price and the

call bid price. Those are trades you can execute in the real world. Using the last trade price does not

guarantee a fill for either the stock or the option. Also, a good option calculator will give you both the

absolute return as well as the annualized return, so that you can compare options with different

expiration dates. Using a covered call calculator will save you tons of time and aggravation. There are

just too many variables to worry about to do it manually without making errors.

The best covered call calculator, of course, is the one that you will feel most comfortable with. If it's too

complicated and you don't use it then it doesn't matter how good it is. Likewise, if it's too simple and

doesn't do what you want then why use it. Good covered call calculators are smart about several things:

knowing the difference between the bid, ask, and last trade prices; knowing about ex-dividend dates

(and amounts); and knowing about earnings release dates (and whether or not they occur before option

expiration). The calculator should express return numbers in several forms: If-flat, If-called, and

Annualized-if-flat and Annualized-if-called. Different investors prefer different kinds of return

calculations and your calculator should do them all. There is a question about dividends: Should you

include them in the return calculations or not? Most investors prefer that you include them, but that

requires the calculator to know about ex-dividend dates and the rules for receiving the dividends or not.

The best covered call calculator is also the one that knows about factors beyond the stock and option

prices. For example, it should know about ex-dividend dates and earnings release dates, and whether or

not they occur before option expiration. These are critical factors for the covered call investor. It is also

nice if the covered call calculator will compare the option you have shorted against a set of alternatives,

and then show you the differences in absolute profit, return calculations, and break even points. By

doing that the investor can compare the risk/reward profile of rolling his (or her) position vs not rolling it

and just letting the current option expire (or get called away at expiration). Lastly, the calculator needs

to import current market prices during market hours. It's just too difficult to make real time decisions if

the calculator only has access to end of day pricing. Normally 15-minute delayed pricing is enough.

Information Source: BornToSell