Trade Journal: Covered Call Writing Example

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Writing a trade plan and keeping a trade journal is not too complicated for the novice trader. In fact, taking the time to read about your earliest trades is an excellent way to learn how your own thoughts developed and how you (hopefully) matured as a trader.

The sample plan below is wordy, and you may not want to record all of your thoughts in the journal. However, the plan does provide examples of the type of thoughts that should be in writing.

Sample Trade Plan for writing covered calls
Trade date: March 6, 20xx

  1. Stock. I bought 200 shares of XXY Corporation. I like this company because it makes a terrific product -- which I own and use. The company's earnings increased by an average of 8% every year for the past 9 years, and the price to earnings ratio (P/E) is at the lower end of its historical range.This stock does not pay dividends. I am willing to pay the current market price of $45.65 for the stock.
     
  2. Options. I considered two alternatives.
  • I could take a very bullish stance and write two April 50 calls on my 200 shares. They expire six weeks from tomorrow. That gives me an opportunity to earn excellent profits if I am patient and sell my shares at $50. Of course, it is unlikely that XXY will rally by $4 in such a short time. However, I may want to keep the possibility of earning that profit (~$4.35 per share + premium per unit) alive.
     
  • I could adopt a more conservative outlook and sell Apr 45 calls.The premium for these calls is very attractive (~$300) and I have a chance to earn more than 5% on my investment in only six weeks. To earn that 5%, XXY has to be above $45 when the market closes for trading on expiration day, Friday, Apr 18, 20xx.

    Important side note to myself: There is an excellent chance of earning that 5% because the stock does not have to rally. In fact, if it remains where it is, or even declines by no more than $0.65, I'll still sell my shares at $45 when expiration arrives. That is important because my stock picks do not always move higher. With this trade, I have some cushion -- 65 cents per share. To earn the maximum with the bullish alternative, the stock must move to $50, a 9.5% increase.

    NOTE: I am not concerned about buying stock @ $45.65 and then selling it at $45. The ~$300 in option premium represents the source of my profit.
     
  • Because I am new to options trading, I am taking the more conservative approach. Earning 5% that quickly is more than satisfactory. I plan to use options as a way to earn extra money -- while trying to reduce the chances of losing money.
     

3. The trade. I enter this order as a single transaction. I will buy stock and sell calls at the same time. 

  • Stock: Currently $45.64 bid; $45.68 ask
  • XXY Apr 18 'xx 50 call (NOTE: I am now familiar with option symbols. XXY is the stock symbol; Apr 18 is the expiration date; 20xx is the year; 50 is the strike price; "call" assures me that I am not selling the put by mistake.) Currently $3.00 bid; $3.20 ask.
     
  • Thoughts about my order: I know that it is important to get a good fill (trade execution) and I will not pay the asking price for stock. Nor will I sell the call option at its bid price. I will try to do better. But, I can always change my limit price later.
     
  • Using my broker's order-entry platform, I enter an order for a buy-write transaction. (A buy-write is a single transaction that results in owning a covered call position.) I want to buy 200 shares of XXY and sell two XXY Apr 18 'xx 45 calls. Note: I do not specify a price for either portion of the trade. I enter an order with a (never use a market order) of $42.58 debit. Translation: Pay no more than $42.58 per unit. Be sure NOT to enter the total dollar cost for buying 200 shares and selling two calls. We always enter orders per stock share or per option.
     
  • NOTE: It does not matter how much I pay for stock nor how much premium I collect when selling the options. The only price that matters is the DIFFERENCE  between those two prices because that is the DEBIT that I am paying (per unit) for this position. 

    If I pay $42.58, I don't care if my trade execution prices are

       $45.68 for stock; and $3.10 for the calls; or
       $45.65 for stock; and $3.07 for the calls or any other variation.

    All that matters is that the stock price minus the call premium is no higher than the limit price of $42.58 per unit.
     

4. Target Profit. I plan to hold this stock until expiration week (Apr 14 - 18). At that time I may decide to "roll" my position by buying those calls I sold and replacing them by selling calls that expire in May (or June).  But right now, my plan is to earn the maximum possible reward and that occurs when the stock is above the strike price ($45) and I am assigned an expiration notice.

I know not to expect that notice any earlier than expiration. 

Calculating Profit:
Sale price: $45.00 (I must not forget to subtract commissions).
Purchase price $42.58.
Net gain: $242 per unit
ROI (return on investment): 5.68% before commissions.  ROI = profit / investment; or $242 / $4,258.
 

5. Maximum acceptable loss. if it turns out that I am wrong about the future prospects of XXY and the stock price heads lower, there has to be some point at which I want to cut my loss. Because my cost for this covered call position is $42.58, that is my break-even price on the downside.

If the stock price dips below $40, I will take defensive action.  If I elect to exit, I sell stock at $40 and repurchase the Apr 50 calls. I do not know what the call price will be at that time (because I have no idea about when this action will be necessary), but I estimate the price @ $0.90. That means I collect only $39.10 credit per unit (sell stock @ $40; buy call @ $0.90).

Net loss: $348 per unit ($696 total). That is the worst loss I anticipate taking on this trade.

Risk Management alternative: I do not have to exit the position. I could decide to cover (repurchase) the Apr 50 calls and write new calls with a lower strike price -- perhaps XXY May 16 'xx 40 calls. I would collect cash for making this trade, (perhaps $250 to 320). I would do this ONLY (repeat: ONLY) when I want to maintain a long position in XXY stock. Warning: NEVER make this trade in an attempt to avoid locking in a loss. If I no longer want to own the stock, I will accept my loss and move on.
 

6. Worst case scenario. I have no idea what that can be when owning stock, but I'll assume that this stock cannot decline below $20 without giving me an opportunity to exit at some higher price. Of course, I remain vulnerable to a gap opening that results from horrible company news. That would represent a huge loss, but I estimate the worst case to be losing ~$2,250 per unit. That will not devastate my account and I am willing to take this very minimal risk.

 

You can include any other material that you believe will prove helpful in your journal. And of course, your actual plan would have far fewer words.