Covered Call Strategies

[boilermaker75]

I'd have to wonder what kind of damage these weekly and/or monthly options strategies would have done to portfolios in 2008 and early 2009.

 

In other words...how safe is this in a market that is sliding hard?

 

Any way to hedge against such a scenario?

 

How safe is it to just buy the common stocks and not write calls?

 

The expiring option premium cushions the fall.

 

Without the option premium, you take the full brunt of the onslaught.

 

So, how did it do?  Relatively better during the fall, relatively worse during the rally (the market rallied so hard that you would have done better to not write calls).

 

Exactly. Plus what else can you do with excess cash in this low interest rate environment than write cash-secured puts on quality businesses?

[boilermaker75]

boilermaker75,

 

i also do some put writing. however i don't see how you can get 18% return !?

 

usually weekly options have very small premium, i guess due to the nature of the market (up) you rarely get put to?

how much of a discount do you typical write puts for in terms of the strike price?

 

 

i guess i have been very conservative in terms of put writing. usually the strike price is a lot lower than the stock price (20 to 50%) or its long dated so i can get enough yield (usually i want at least 10% return annualized in order for more the write the puts)

 

what about you? what do you typically do?

 

thanks

hy

 

 

 

hy,

 

When I write a put with an expiration date about a month away I look for >1% return for that month. I can often find situations where I can do much better than this, like COH and IBM recently right after earnings. See my posts in the COH thread where I think I mentioned some positions I wrote.

 

Weekly options have the highest annual percentage returns. Look at the IBM 180-strike Nov 22 expiration puts. They are bid at $0.80. (They were a lot higher earlier this morning.) If I trade at IB, I'll usually get a fill that after commissions will still result in $0.80 per share. So my return for 8 days would be 0.46%. Note if I get put to at IB there is no commission for the stock purchase so it is also a good potential limit order if you wanted IBM at $180.

 

I'm usually looking at a strike price that is at- or just out-of-the money for an expiration date that is 1-8 days away. For some longer term puts I will look at strike prices a few percent out-of-the money.

 

Boiler

 

 

It seems like you would get put to quite often with that strategy.  How often does this happen?  Half the time?  Less than half?

 

Not really, this is just a guestimate but less than 10%. I don't write puts unless the strike price is attractive. I probably won't be put to on any of my put positions that expire this week, ACN at $75, COH at $50 and $52.50, BAC at $14, MDT at $45 (this was a position I wrote in July), IBM at $180, BRK/B at $115, KO at $39 and $39.50, MCD at $97.50, PSX at $57.50, EXC at $28, KLIC at $12, and DTV at $60.

 

My other open put positions are Nov 22 MCD at $97 and $98, Nov 29 IBM at $170, and for Dec. so far PSX at $57.5, $BRK/B at $115, and BAC at $14. I also have ORCL $35-strike December covered calls, which is equivalent to a naked put. ORCL was one I was put to at $34.50 and I replaced with some lower basis ORCL and I want to be called out.

 

With all those positions, how do you size them? Heaven forbid, what if you got put to on all your positions? What would your portfolio look like then? What hurdle rate to you tend to aim for?

 

Whenever I write puts (I am a novice at this), I make sure that the underlying would not cause me to go on margin if I were being put to. I also would only have about one or two put contracts open. I'm probably too concentrated...

 

Thanks Boiler!

 

I don't mind if I get put to because these are quality businesses at good prices. Many of these companies I have a LT position in-- so I am comfortable owning them and I am familiar with them. With this market I am more careful and if I get put to on everything I am currently short I have just about enough cash to cover. Also I'll only write additional puts if some of the ones I am currently short have moved well out-of-the money.

 

In this low-interest rate environment this is a good use of excess cash.

 

I like to get >1% when I write an option about a month out. The shorter the time to expiration the better you can do on an annual basis and why I am active with the weekly options.

 

 

[rkbabang]

I don't mind if I get put to because these are quality businesses at good prices. Many of these companies I have a LT position in-- so I am comfortable owning them and I am familiar with them. With this market I am more careful and if I get put to on everything I am currently short I have just about enough cash to cover. Also I'll only write additional puts if some of the ones I am currently short have moved well out-of-the money.

 

In this low-interest rate environment this is a good use of excess cash.

 

I like to get >1% when I write an option about a month out. The shorter the time to expiration the better you can do on an annual basis and why I am active with the weekly options.

 

This is a safe strategy if you always hold enough cash to cover and you don't mind being put to, which is why I was asking how often you get put to.  Even though you don't mind when it happens, it reduces your cash and your ability to use this strategy in the future unless you raise more cash (add new cash or sell something).  With weekly options it seems to me that a relatively small movement in the price could result in being put to, which is why I'm surprised it doesn't happen to you often.  You must really know these stocks well wrt how they trade.  Back when I was writing covered calls a few years back I noticed that the stock price could often do strange things right before the options expired.  Maybe this was due to the fact that I was writing calls on a relatively small company.  Anyway, it bit me, my shares were called away when I didn't want them to be.

 

Thanks for all your info.

[boilermaker75]

I don't mind if I get put to because these are quality businesses at good prices. Many of these companies I have a LT position in-- so I am comfortable owning them and I am familiar with them. With this market I am more careful and if I get put to on everything I am currently short I have just about enough cash to cover. Also I'll only write additional puts if some of the ones I am currently short have moved well out-of-the money.

 

In this low-interest rate environment this is a good use of excess cash.

 

I like to get >1% when I write an option about a month out. The shorter the time to expiration the better you can do on an annual basis and why I am active with the weekly options.

 

This is a safe strategy if you always hold enough cash to cover and you don't mind being put to, which is why I was asking how often you get put to.  Even though you don't mind when it happens, it reduces your cash and your ability to use this strategy in the future unless you raise more cash (add new cash or sell something).  With weekly options it seems to me that a relatively small movement in the price could result in being put to, which is why I'm surprised it doesn't happen to you often.  You must really know these stocks well wrt how they trade.  Back when I was writing covered calls a few years back I noticed that the stock price could often do strange things right before the options expired.  Maybe this was due to the fact that I was writing calls on a relatively small company.  Anyway, it bit me, my shares were called away when I didn't want them to be.

 

Thanks for all your info.

 

The fact I haven't been put to too often in the last few years is more likely because the market direction has been upward. This wasn't the case back in 2008-2009 when this strategy put me on margin. But those companies I acquired back then, WFC, BAC, BRK, GE, BBT, etc. ended up doing well and I still own many of them. With where the market is today, I am starting to be more cautious.

[boilermaker75]

boilermaker75,

 

i also do some put writing. however i don't see how you can get 18% return !?

 

usually weekly options have very small premium, i guess due to the nature of the market (up) you rarely get put to?

how much of a discount do you typical write puts for in terms of the strike price?

 

 

i guess i have been very conservative in terms of put writing. usually the strike price is a lot lower than the stock price (20 to 50%) or its long dated so i can get enough yield (usually i want at least 10% return annualized in order for more the write the puts)

 

what about you? what do you typically do?

 

thanks

hy

 

 

 

hy,

 

When I write a put with an expiration date about a month away I look for >1% return for that month. I can often find situations where I can do much better than this, like COH and IBM recently right after earnings. See my posts in the COH thread where I think I mentioned some positions I wrote.

 

Weekly options have the highest annual percentage returns. Look at the IBM 180-strike Nov 22 expiration puts. They are bid at $0.80. (They were a lot higher earlier this morning.) If I trade at IB, I'll usually get a fill that after commissions will still result in $0.80 per share. So my return for 8 days would be 0.46%. Note if I get put to at IB there is no commission for the stock purchase so it is also a good potential limit order if you wanted IBM at $180.

 

I'm usually looking at a strike price that is at- or just out-of-the money for an expiration date that is 1-8 days away. For some longer term puts I will look at strike prices a few percent out-of-the money.

 

Boiler

 

 

It seems like you would get put to quite often with that strategy.  How often does this happen?  Half the time?  Less than half?

 

Not really, this is just a guestimate but less than 10%. I don't write puts unless the strike price is attractive. I probably won't be put to on any of my put positions that expire this week, ACN at $75, COH at $50 and $52.50, BAC at $14, MDT at $45 (this was a position I wrote in July), IBM at $180, BRK/B at $115, KO at $39 and $39.50, MCD at $97.50, PSX at $57.50, EXC at $28, KLIC at $12, and DTV at $60.

 

My other open put positions are Nov 22 MCD at $97 and $98, Nov 29 IBM at $170, and for Dec. so far PSX at $57.5, $BRK/B at $115, and BAC at $14. I also have ORCL $35-strike December covered calls, which is equivalent to a naked put. ORCL was one I was put to at $34.50 and I replaced with some lower basis ORCL and I want to be called out.

 

Of the above positions that expire this weekend, I will be put to on MCD at 97.50. I also will be put to on MCD at 97, a short put position I missed above. I would be happy holding MCD at these prices, but I have a full position in MCD. So I will be writing covered calls on these positions.

[boilermaker75]

Another place I write puts, instead of buying the stock, is in risk arbitrage plays. If you buy the stock your return is uncertain because you don't know for sure when the deal will close. If instead you write the put, you know the day your deal closes so you know your return. Plus you can use a much shorter time to expiration of the put than the time to when the deal will close and probably have much less risk.

 

The last time I did this was with recent Privatization of DELL.

[frommi]

Has someone read the book http://www.edwardothorp.com/sitebuildercontent/sitebuilderfiles/beatthemarket.pdf and tried his Warrant strategy with Call options where the underyling has a high implicit volatility?

I just looked for fun and found some where with a 1:3 (1 stock, 3 written call options) split the underlying can move between -36% and +16% (in 4 weeks) and i am still in profit. With the example i have choosen i could make 300% annualized when the stock doesn`t go anywhere for 4 weeks. The problem is obvious because in case of black swan events the whole portfolio can be wiped out.

But perhaps with a good money management and diversification this can be controlled. I really can`t imagine that i am the first to figure that out.

 

Is high volatility reverting to the mean?

[rayfinkle]

One are where I've found interesting opportunities to write insurance is on reits. This way you can recreate the dividend (or better) while having an aggressive limit on buying the stock. I find that writing these following a few rules helps me sleep well:

-write only on companies you want to own

-at prices you are comfortable owning them

-be diligent about knowing where returns come from (time value, Iv, etc)

[rayfinkle]

Separately, any recs for good tools to compare implied volatility to historically for a given strike and duration?

[Straddle]

I have written covered calls from time to time...

 

Generally, I think it is a good strategy.  I especially like to write covered calls on stocks that I have large gains in.

 

Sometimes it backfires though.  A few years back, I bought Western Refining (WNR) at something like $3.90 a share.  It went up about $.75/share, so I wrote some calls with a strike of 5.  Worked great!  pocketed the premium.  Did it again, same result!  WNR then started to run, so I held off a bit...I was then sitting on over a double, so I wrote some calls with a strike of 10.  This time, WNR blew through it and the stock was called.  In the time after that, WNR went into the 40's.  So I lost a lot of the upside...

 

I think if you are judicious, covered call writing could reduce volatility and add a couple points of return to your portfolio.

 

Very familiar with that. All in all,  covered calls are good for raising some cash and hedging your total portfolio for a little bit, but all in all I don't like it. With covered calls you off all the upside potential from your stocks for a few fast bucks. Also in case of a cash you're not protected at all. I'd rather buy LEAPS or sell vertical call (credit) spreads.

[Straddle]

Has someone read the book http://www.edwardothorp.com/sitebuildercontent/sitebuilderfiles/beatthemarket.pdf and tried his Warrant strategy with Call options where the underyling has a high implicit volatility?

 

I have read the book, but it was so outdated. Like the comments say on Amazon, it was a good method before Black & Scholes formulas were around and when there still were numerous mispricings in options. Nowadays with all the HFT and algorithms trading options I don't think it will give much of an edge.

 

I just looked for fun and found some where with a 1:3 (1 stock, 3 written call options) split the underlying can move between -36% and +16% (in 4 weeks) and i am still in profit. With the example i have choosen i could make 300% annualized when the stock doesn`t go anywhere for 4 weeks. The problem is obvious because in case of black swan events the whole portfolio can be wiped out.

But perhaps with a good money management and diversification this can be controlled. I really can`t imagine that i am the first to figure that out.

 

You're just being short gamma, I have already done trades like that for small portions of my capital. Nice (annualized) returns, but you're short risk.

 

Is high volatility reverting to the mean?

 

Probably. But defining what's high vol, low vol or mean vol isn't that easy.

[frommi]

I have read the book, but it was so outdated. Like the comments say on Amazon, it was a good method before Black & Scholes formulas were around and when there still were numerous mispricings in options. Nowadays with all the HFT and algorithms trading options I don't think it will give much of an edge.

 

That sounds like the two professors and the 100-dollar note on the street :). I don`t think that stock options are a good way for automated arbitrage because of bid/ask spread and liquidity problems. And i don`t think that it is an attractive opportunity for the big money. After reading a lot the last days and trying it myself, i am really fascinated about it. I started with searching a method to hedge part of my stock portfolio and i think i found that solution with the synthetic put option that has a slight negative delta. My intention is to use overvalued stocks where the options have the highest implicit volatility. When the stock comes to the extremas of the calculated profit range i start to rebalance into a delta neutral state by buying stock or selling more call options depended on the delta of the current option. That way i get the returns from theta and when the implicit volatility of the option doesn`t match the reality. Given that i only buy options with the highest implicit volatility that should be very often the case. I would go so far and say that Black&Scholes has a flaw for pricing because volatility is historical, but the past stock movements have nothing to do with future stock movements (read Taleb on Black&Scholes). And volatility does indeed return to the mean. A screener for difference from mean volatility would be great, but i doubt that one exists public. So i have to go with the highest ones.

 

And now imagine two portfolios one with value stocks and their returns and then the option portfolio. Rebalance when appropriate.

Both have high returns and negative correlation, the end result will be a higher overall return with very low drawdowns and a high sharpe ratio. That is Markowitz portfolio theory.

[bargainman]

I have written covered calls from time to time...

 

Generally, I think it is a good strategy.  I especially like to write covered calls on stocks that I have large gains in.

 

Sometimes it backfires though.  A few years back, I bought Western Refining (WNR) at something like $3.90 a share.  It went up about $.75/share, so I wrote some calls with a strike of 5.  Worked great!  pocketed the premium.  Did it again, same result!  WNR then started to run, so I held off a bit...I was then sitting on over a double, so I wrote some calls with a strike of 10.  This time, WNR blew through it and the stock was called.  In the time after that, WNR went into the 40's.  So I lost a lot of the upside...

 

I think if you are judicious, covered call writing could reduce volatility and add a couple points of return to your portfolio.

 

Very familiar with that. All in all,  covered calls are good for raising some cash and hedging your total portfolio for a little bit, but all in all I don't like it. With covered calls you off all the upside potential from your stocks for a few fast bucks. Also in case of a cash you're not protected at all. I'd rather buy LEAPS or sell vertical call (credit) spreads.

 

The other thing is just not to fully cover..  So if you have 300 shares, sell 1-2 calls, not all 3.  Always leave some upside. Never fully cover...