LOL!'s Market Timing Newsletter

[LOL!]

One can try to sell those calls, but who would pay 4% premium to buy them? I didn't look, but when I did options in the past, volume could be zero and open interest could be 0 for things that were too good to be true.

That is, you cannot use any strike you want because somebody else has to want it and pay for it, too.

 

[utrecht]

One can try to sell those calls, but who would pay 4% premium to buy them? I didn't look, but when I did options in the past, volume could be zero and open interest could be 0 for things that were too good to be true.

That is, you cannot use any strike you want because somebody else has to want it and pay for it, too.

Open interest in the Sept'16 135 puts is 993 contracts. Its 8195 for the 150s. Lots of people pay premium to hedge their portfolios. There is zero open interest for the calls. I don't trade covered calls. I sell puts instead. The profit profile is the same but the puts are normally priced higher.

 

[bmcgonig]

One can try to sell those calls, but who would pay 4% premium to buy them? I didn't look, but when I did options in the past, volume could be zero and open interest could be 0 for things that were too good to be true.

That is, you cannot use any strike you want because somebody else has to want it and pay for it, too.

I did the calculation today using Friday's bid/ask prices. They were a little less than the original article due to the fact (I assume) that the vix is lower at 21 than when he wrote the article at 27, but very close. This also makes the point that it's best to place this bet when the vix is higher.


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[NW-Bound]

Options on individual stocks may be very thinly traded, particularly of smaller companies.

However, options on the S&P can have huge volumes. I just looked and at some strike price, there's nearly 100,000 contracts out. That's 100,000 contracts x 100 shares/contracts x $190/shares = $1.9 billion worth, just at one price.

But then, the market value of all S&P 500 stocks is near $20 trillion, so the total option values may be just a few percent of the assets. I guess institutional investors use them to hedge.

 

[LOL!]

However, options on the S&P can have huge volumes.

Of course there are popular options. I'm saying that it would be unlikely that someone would pay you a lot of money for an improbable event. They might pay you a little bit of money for something that was unlikely to happen.

So when when the trade is made, let us know.

 

[NW-Bound]

Hold on. Let's get this right.

The author of the article shows only 1% as coming from the call premium. The other 3% comes from the S&P dividend plus the effect of reinvestment of the call proceed.

And at the bid/ask price quote, one can usually have an order of a few contracts filled. I have never done as many as 60 contracts of a stock worth $190/shares (million dollar worth!), so do not how deep the queue is. Perhaps one needs some time to build that position. But as I showed, some strike prices already had 100,000 contracts outstanding.

 

[utrecht]

This is how I see it:


Outlay:

1155540
- 201300
=====
$954240

Money Back:

990000 Stock at 1650
+24000 Dividends
=====
1014000


Total Return = 1014000 - 954240 = 59670
% return = 59670/954240 = 6.26

Can you explain this in detail? I always sell puts, not covered calls so I dont understand where these numbers are coming from.

Hes buying 100 shares at 195 and then selling a 165 call for 60? (round numbers) I dont understand his, or your, numbers.

 

[bmcgonig]

Sure. Hope this explains it better.

Hes buying 6000 shares of SPY and selling 60 calls at 165 strike price.



Outlay:

1155540 this is the cost of 6000 shares of SPY
- 201300 this is what he gets from selling the 60 calls
=====
$954240 total cost of doing both trades

Money Back:

990000 Stock at 1650 Expiration day value of the 6000 shares
+24000 Dividends Dividends he received during the year
=====
1014000

 

[bmcgonig]

Heres an example of the 135 calls from Fridays prices



Fridays close of SPY = 195.45
Bid price of the 135 calls = 62

1172700 this is the cost of 6000 shares of SPY
-372000 this is what he gets from selling the 60 calls
=====
$800700 total cost of doing both trades

Money Back:

810000 Expiration day value of the 6000 shares at 135
+24000 Dividends Dividends he received during the year
=====
$834000

Profit = 834000 - 800700 = 33300.
%profit = 33300/800700 = 4.159%

 

[utrecht]

Sure. Hope this explains it better.

Hes buying 6000 shares of SPY and selling 60 calls at 165 strike price.



Outlay:

1155540 this is the cost of 6000 shares of SPY
- 201300 this is what he gets from selling the 60 calls
=====
$954240 total cost of doing both trades

Money Back:

990000 Stock at 1650 Expiration day value of the 6000 shares
+24000 Dividends  Dividends he received during the year
=====
1014000

OK, I dont get 6% return from this. He's calculating his return based on a starting value of $954,240, when his actual starting value is $1,115,540 which he doesn't have. He only has $1,000,000. Since this is an IRA he cant go on margin to buy the 6000 shares. So he would have to buy slightly less shares and sell slightly less calls. In the end his return is going to be closer to 5.2%

Also, there's a very high probability that the calls with get exercised early so the divdends are going to be hard to collect. I know he knows that, but it will happen a lot.

That's one of the many reasons I prefer selling puts.

 

[bmcgonig]

OK, I dont get 6% return from this. He's calculating his return based on a starting value of $954,240, when his actual starting value is $1,115,540 which he doesn't have. He only has $1,000,000. Since this is an IRA he cant go on margin to buy the 6000 shares. So he would have to buy slightly less shares and sell slightly less calls. In the end his return is going to be closer to 5.2%

Also, there's a very high probability that the calls with get exercised early so the divdends are going to be hard to collect. I know he knows that, but it will happen a lot.

That's one of the many reasons I prefer selling puts.

He has a million and he's using 954k of that. Thats buys the 6000 shares and sells the 60 calls. That's the starting value. Plus he has the extra 46k to use how he wants.

You could be right about the dividends, I just don't know when they're more likely to be called.


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[Fermion]

I haven't found early exercise to be much of a problem actually. I have some really deep in the money plays that I would have thought would be exercised for the dividend, but nope.

 

[bmcgonig]

He has a million and he's using 954k of that. Thats buys the 6000 shares and sells the 60 calls. That's the starting value. Plus he has the extra 46k to use how he wants.

One thing to remember that might clear it up is that he doesn't need to go on margin to buy the stock. He can execute a "buy-write" combined trade that subtracts the proceeds of the sold calls from the price of the stock, so the total is 954k, i.e., under his million.

 

[Fermion]

As for why there may be interest in these deep in the money calls, it might not just be for portfolio insurance.

Consider that someone might create a call spread, by buying the $165 calls and selling closer to the money calls, like $190 calls. If they do that for $20 and make a 25% return, then this provides a market for the deep calls when it was thought there was little interest in them. Everyone wins!

 

[utrecht]

OK, I forgot you could do the covered call as one transaction. Makes more sense now. As far there be no open interest, I guarantee that if I put an order in right now to buy or sell those calls and I put my limit order between the bid and ask, it will get filled within a few minutes.

 

[utrecht]

Overall, I think this strategy is a very very low risk and conservative way to use options to juice your portfolio returns a bit.

 

[Fermion]

Recent [Mod Edit] comments about drug pricing control plan created some bargains in biotech land today. I am in for a few ten k of various bios that dropped 3%...I expect they will bounce back later this week if the market continues up.

 

[NW-Bound]

... Everyone wins!

No, I believe someone still loses.

In the case of the conservative deep-in-the-money covered call strategy of SPY at 165 we have been talking about, if the market drops the article author still gets his 6% gain up until the market is down 15% from the current level. After that he still loses, but less than the market. His gain relative to a buy-and-holder comes out of whoever buys the calls from him. Now, his call buyer might have hedged his own way, and passes the loss to another market strategist, or spreads it around several other market players, but someone loses.

And on the other side of the coin, if the market goes up 10% which is really 12% after dividends, the article author is still stuck at his 6% objective gain. His underperformance of 6% relative to the market is now extra gain in the pocket of his call buyer, who is holding an appreciating asset.

The only mechanism that "prints money" and gives most everyone more is for the market to go up. In a bull market, everybody feels like a genius, whether he wins a little by investing conservatively, or a lot by leveraging. In a bear market, if I lose less than the market, I should feel smug.

 

[jetpack]

selling on the top of the up day, I feel happy. having cash to invest on a down day.. ok. ... but if it keeps going down, oh my

 

[bmcgonig]

No, I believe someone still loses.

In the case of the conservative deep-in-the-money covered call strategy of SPY at 165 we have been talking about, if the market drops the article author still gets his 6% gain up until the market is down 15% from the current level. After that he still loses, but less than the market. His gain relative to a buy-and-holder comes out of whoever buys the calls from him. Now, his call buyer might have hedged his own way, and passes the loss to another market strategist, or spreads it around several other market players, but someone loses.

And on the other side of the coin, if the market goes up 10% which is really 12% after dividends, the article author is still stuck at his 6% objective gain. His underperformance of 6% relative to the market is now extra gain in the pocket of his call buyer, who is holding an appreciating asset.

The only mechanism that "prints money" and gives most everyone more is for the market to go up. In a bull market, everybody feels like a genius, whether he wins a little by investing conservatively, or a lot by leveraging. In a bear market, if I lose less than the market, I should feel smug.

I executed the trade this morning. 700 shares of SPY and 7 calls at 145 (not 135). Theoretical gain for the year will be 4.42%. I did this with Fixed Income part of my portfolio. The rest is in bonds and CDs.

If the market tanks to 1450 over the next year I think I would be rebalancing into stocks anyway, and the amount that I would rebalance and the amount of SPY are similar. I'm well aware this is yield chasing, but so far I cant see a downside, but I've been myopic before

The trade didnt go through at midpoint between bid and ask, I had to wait until the bid moved up (as the market went lower I think).

 

[NW-Bound]

This locking-in of a modest 4.42% gain is reasonably safe, and it is not at all like yield chasing, meaning buying high-dividend stocks.

I like it a lot better than buying bonds that barely cover inflation right now yet have higher risks. And yes, if the market crashes that hard and you are forced to hold the stock, it may be good for you long-term anyway.

A problem I see in the execution is the timing between buying the shares and selling the options. With the market as crazy as it has been, a time skew between the two actions might cause your return to be a bit more or less than what you initially compute.

And the perfect time to lock in this 4.42% return was earlier, when the market was higher so that we started at a higher base. Sigh... No, I take this back. If the cash to buy comes from a bond or fixed-income, then it does not matter when the strategy gets implemented. I was thinking about my own recent stash of cash that came from changing stock AA from 70% to 60%.

 

[bmcgonig]

This locking-in of a modest 4.42% gain is reasonably safe, and it is not at all like yield chasing, meaning buying high-dividend stocks.

I like it a lot better than buying bonds that barely cover inflation right now, yet have higher risks. And yes, if the market crashes that hard and you are forced to hold the stock, it may be good for you long-term anyway.

A problem I see in the execution is the timing between buying the shares and selling the options. With the market as crazy as it has been, a time skew between the two actions might cause your return to be a bit more or less than what you initially compute.

its executed as one trade, as a "buy write", so that's not an issue. However the bid and ask for the options are far apart, so that could skew it. I calculated out the potential % gain before making the trade by using the latest "bid" in the calculation.

Actually the one thing that might determine the percentage the most is the VIX. The higher the better since you're selling calls. In the original example from the article he was using a VIX of 27 which delivered better results I think.

 

[utrecht]

Lets us know if the calls get executed early. I think its a good trade.

 

[NW-Bound]

I just looked and saw the volume of 7 contracts of yours at that strike price, and no others today.

That brings the open interest to 143 contracts out for that particular call.

 

[utrecht]

You will collect more premium when the VIX is high but you cant really worry about that. If you plan to do this on a regular basis every year, then you cant be out of the market waiting for the VIX to rise or you could be waiting a long time with your fixed income portion doing nothing which will chew away slowly at your return.

You could split the fixed income portion into 4 portions and make 4 overlapping quarterly trades sort of like laddering bonds. That way you would get a variety of VIX levels and not get stuck with one super low VIX value (although we are still above the historical VIX avg right now)