Selling Covered Calls and Naked Puts

[Sojourner]

Many people think of what I do as work, but I enjoy it as a pastime. I don't watch TV, play no computer games, and do not read fictions (I do enjoy non-fictions), play no card games, etc... This is one of my pastimes.

I'm with you, for the most part (although I do watch TV and play card games). I really enjoy selling my monthly puts and calls, which I'll be doing again tomorrow and Tuesday. But I do wonder—in your case where you're making roughly $300K/year on it—would you feel any sort of financial pressure to make up some of that lost income if you were to stop selling options? I feel like there might be some fuzzy "line in the sand" beyond which it's not as carefree as a pastime but has some performance and pressure aspects... kind of like a j*b. Another way of asking this might be, do you include your options income in your FIRECalc data in the "Other income" section? Or is it purely icing, such that the lifestyle you're living in ER would not be affected materially if it were to disappear?

 

[NW-Bound]

... But I do wonder—in your case where you're making roughly $300K/year on it—would you feel any sort of financial pressure to make up some of that lost income if you were to stop selling options?

... I am not sure. A lot of my Web surfing time used to be to look for travel info, and to plan the itinerary for my own European auto trips, and domestic RV treks. As mentioned, the option trading brought me only $113K in 2019, but grew to $320K in 2020, principally because I had more time being locked up at home.

I am looking to be able to travel again, and think I will not miss option trading while I travel. I already have too much unspent money to crave having more.

... I feel like there might be some fuzzy "line in the sand" beyond which it's not as carefree as a pastime but has some performance and pressure aspects... kind of like a j*b. Another way of asking this might be, do you include your options income in your FIRECalc data in the "Other income" section? Or is it purely icing, such that the lifestyle you're living in ER would not be affected materially if it were to disappear?

I do feel not a pressure but a desire to see if I can refine my tactics, to do better and better. Not like a job, but like a chess player who wants to get better, or a runner who can do a marathon in less time.

No, I never count the gain from option selling as some income that is taken for granted, like a pension or rental income in FIRECalc. I look at it as excess market return, not too differently than excess gain over the market index because I happen to pick a hot stock this year. There's no guarantee that I will be able to beat the market year-in/year-out.

About this gain affecting my lifestyle, I have been telling my wife I am certainly doing it for the fun aspect, because our expenses have not budged, and I have no major expenses planned.

Right now, my WR of less than 1% is more than covered by interest and dividend incomes. I don't even need the equity capital gain, let alone the extra from options. I count the option gain simply as a measure of the "economic worthiness" of this activity. How gainful is this activity, aside from the fun?

 

[Sojourner]

No, I never count the gain from option selling as some income that is taken for granted, like a pension or rental income in FIRECalc. I look at it as excess market return, not too differently than excess gain over the market index because I happen to pick a hot stock this year.

That seems like the right way to look at it. Not as guaranteed or dependable income, but somewhat like "windfall" income that you could use for some amount of splurge spending, etc. Even though I feel fairly certain I could generate $3k/month selling options pretty much every month, I don't want to develop the mindset that it's a dependable, automatic income stream.

 

[NW-Bound]

It is not easy to do accounting to see the effects of option selling. It's simple if none of the contracts get assigned. In my case, as described earlier, by careful analyzing actual trade records, I discovered that the ratio of my contracts getting assigned was a lot higher than I thought.

If you have to sell some shares due to calls getting assigned, and have to buy others due to puts being assigned, it may mean that you are selling too soon some good stocks, and buying inferior stocks that perhaps you should not touch.

In other words, would I have more money if I did not do option? I would not get the $320K in option premium, but perhaps I would get even more when the stocks I had to sell went up further.

But then, if you go too far, it becomes a question of "What if", and that will never end. First, you ask yourself, if I did not get the call assigned on stock XYZ, which later climbed up even more, I would have more money if I did not fool around with option selling.

And then, you may ponder, why did I not sell stock ABC and put that money into XYZ?

Lots of wouldda, shouldda, if you don't know when to stop.

And that's why, in the end, I look at the total portfolio return, and ask if that is good compared to simple indexing with a 60/40 AA, or putting it all into Wellesley/Wellington and calling it quit.

One thing is for sure though. If I had done this in an after-tax account, my tax bill would be horrific due to lots of short-term cap gain.

 

[chassis]

@NW-Bound what is your view of Roth conversions? If you are trading options in a tax advantaged account, Roth conversion would decrease your dry powder for options trading, correct?

 

[NW-Bound]

I think it may come out in a wash. Roth conversion costs me some money to pay taxes, but after that I can trade with no concern for taxes, just as with an IRA.

No tax liability and no tax filing means I can plan my moves for the most gain, without having to think about short-term/long-term tax rates. Else, it's too tough to know what's the right move.

It's just that right now, our Roth accounts are not even 1/10 of our investable assets. By the time I convert enough, I may be too old to do option trading, or stop caring.

 

[Dan32]

I just looked through most of this thread and have a couple of questions. For background I also buy call leaps and sell some calls against those as a part of my asset allocation. I've been more consistently successful when using this strategy against index ETFs (SPY, QQQ, and IWM) I also use some other option strategies occasionally but find these to be more time consuming to manage. Some of my questions are:

1. When you buy leaps and sell calls against those, what delta values and expiration dates due you use to guide you?

2. Do you use IV rank or percentile to guide you in which options to buy or sell?

3. Do you typically let the options go to expiration or do you manage them early (for example 21 days prior to expiration)?

4. Do you include these options in your asset allocation and if so how do you value them? For disclosure - I do include them in my allocation, but use a combination of option net liquidity and underlying asset value. I'm looking for a better way however, due to the changes in the extrinsic values of the options with time and changes in the underlying price which makes this method cumbersome.

Thanks for any answers!

 

[jr6035]

I just looked through most of this thread and have a couple of questions. For background I also buy call leaps and sell some calls against those as a part of my asset allocation. I've been more consistently successful when using this strategy against index ETFs (SPY, QQQ, and IWM) I also use some other option strategies occasionally but find these to be more time consuming to manage. Some of my questions are:

1. When you buy leaps and sell calls against those, what delta values and expiration dates due you use to guide you?

2. Do you use IV rank or percentile to guide you in which options to buy or sell?

3. Do you typically let the options go to expiration or do you manage them early (for example 21 days prior to expiration)?

4. Do you include these options in your asset allocation and if so how do you value them? For disclosure - I do include them in my allocation, but use a combination of option net liquidity and underlying asset value. I'm looking for a better way however, due to the changes in the extrinsic values of the options with time and changes in the underlying price which makes this method cumbersome.

Thanks for any answers!

1. Around a 30 Delta. No more than 45 days out. Only OTM.

2. I don't pay attention to that.

3. Expire. Or close if it's close to my strike if it's a couple days from expiry. Thats if it's a stock that I keep forever. A "trade" sell, I don't care if it's assigned.

4. No.

 

[Dan32]

Thanks jr6035.

I used to use a 0.3 delta also, but switched to around a 0.16 delta about a year ago. I had too many calls that went into the money due to the markets rapid increase. There is also one brokerage house (that I don't use) that recommends 0.16 based on a study they did. They also recommend managing at 21 DTE. While I've been using the 0.16 delta, I've only been using the 21 DTE less than about 25% of the time (usually when the sold call has moved further out of the money).

While I like to receive the premium, I don't consider it an enhanced dividend. Instead I look at it as a way to offset the extrinsic value I pay for the LEAP. Using options in this way, with the proper asset allocation (increased cash and preferred allocation) allows me to reduce risk without overly sacrificing potential return.

I rarely let anything get assigned. I never considered it if it's a poor man's covered call, which is what most of mine are.

 

[jr6035]

Thanks jr6035.

I used to use a 0.3 delta also, but switched to around a 0.16 delta about a year ago. I had too many calls that went into the money due to the markets rapid increase. There is also one brokerage house (that I don't use) that recommends 0.16 based on a study they did. They also recommend managing at 21 DTE. While I've been using the 0.16 delta, I've only been using the 21 DTE less than about 25% of the time (usually when the sold call has moved further out of the money).

While I like to receive the premium, I don't consider it an enhanced dividend. Instead I look at it as a way to offset the extrinsic value I pay for the LEAP. Using options in this way, with the proper asset allocation (increased cash and preferred allocation) allows me to reduce risk without overly sacrificing potential return.

I rarely let anything get assigned. I never considered it if it's a poor man's covered call, which is what most of mine are.

.30 Delta is a ballpark figure. On my keeper stocks, IBM, MMM, JNJ, KMB and a few others, I go lower. I don't do LEAPS, but are they the same as a Roll? 21 DTE is about average for me also. A book I have recommends 30-45.

 

[Dan32]

A LEAP is just a call buy with an expiration date a year or more in advance. I like to buy a leap with a delta of ~0.7 to 0.8. For example if I bought the SPY Sep 16, 2022 390 calls it would cost ~$67 per share (current SPY price ~ 438). Of this ~$19 would be in extrinsic value which will go to $0 in extrinsic at expiration, so I try to sell calls against this to offset this decay in value.

I sell the OTM calls against these positions ~45 days to expiration. At about 21 DTE I will look at either buying these back if I've made more than 1/2 the potential profit (with the ida of selling them again if the underlying moves higher) or rolling them into a longer expiration date. With SPY and QQQ there are lots of expiration dates with decent volumes. However as I said in a previous post most of the time I end up not doing anything at 21 DTE and letting the position go until expiration or close to it.

 

[jr6035]

It is not easy to do accounting to see the effects of option selling. It's simple if none of the contracts get assigned. In my case, as described earlier, by careful analyzing actual trade records, I discovered that the ratio of my contracts getting assigned was a lot higher than I thought.

If you have to sell some shares due to calls getting assigned, and have to buy others due to puts being assigned, it may mean that you are selling too soon some good stocks, and buying inferior stocks that perhaps you should not touch.

In other words, would I have more money if I did not do option? I would not get the $320K in option premium, but perhaps I would get even more when the stocks I had to sell went up further.

But then, if you go too far, it becomes a question of "What if", and that will never end. First, you ask yourself, if I did not get the call assigned on stock XYZ, which later climbed up even more, I would have more money if I did not fool around with option selling.

And then, you may ponder, why did I not sell stock ABC and put that money into XYZ?

Lots of wouldda, shouldda, if you don't know when to stop.

And that's why, in the end, I look at the total portfolio return, and ask if that is good compared to simple indexing with a 60/40 AA, or putting it all into Wellesley/Wellington and calling it quit.

One thing is for sure though. If I had done this in an after-tax account, my tax bill would be horrific due to lots of short-term cap gain.

You can always buy the stock back, right?

 

[jr6035]

A LEAP is just a call buy with an expiration date a year or more in advance. I like to buy a leap with a delta of ~0.7 to 0.8. For example if I bought the SPY Sep 16, 2022 390 calls it would cost ~$67 per share (current SPY price ~ 438). Of this ~$19 would be in extrinsic value which will go to $0 in extrinsic at expiration, so I try to sell calls against this to offset this decay in value.

I sell the OTM calls against these positions ~45 days to expiration. At about 21 DTE I will look at either buying these back if I've made more than 1/2 the potential profit (with the ida of selling them again if the underlying moves higher) or rolling them into a longer expiration date. With SPY and QQQ there are lots of expiration dates with decent volumes. However as I said in a previous post most of the time I end up not doing anything at 21 DTE and letting the position go until expiration or close to it.

Kinda get it, but I'll stick to selling calls on the stocks I own. I just do it far enough out, 30-45 days, that they won't get assigned. And if any did, I would just buy it back. Only happened once.

 

[NW-Bound]

You can always buy the stock back, right?

Sure.

But I hate having to buy the stock back at a higher price than the strike price of the call that just got assigned. I just forfeited some gains, even with the premium of the call accounted for.

Sometimes, a put at the same strike price or even a lower strike price got me back the stock. Some other times, a good stock keeps climbing out of sight.

 

[jr6035]

Sure.

But I hate having to buy the stock back at a higher price than the strike price of the call that just got assigned. I just forfeited some gains, even with the premium of the call accounted for.

Sometimes, a put at the same strike price or even a lower strike price got me back the stock. Some other times, a good stock keeps climbing out of sight.

I always have 50 or more shares that I didn't sell a call on, in case it's assigned and keeps going up. I seldom do more than 1 contract. Except on KO or VZ, that just slowly chug along. Their premiums are low, so I'll do 2 or 3 contacts to make it worth my while. SO is also good for a couple contracts. A premium has to be above $50 to be worth my while. And stocks with weekly calls.

 

[NW-Bound]

My intention was not to "lose" the stocks that I was bullish on. But the premium on hot stocks was so high that the temptation was often too great to resist.

I just lost a round lot of KLAC in my account to a 355 call, then another lot of KLAC in my wife's account to a 365 call.

Immediately wrote a put at 355, and a put at 365, but it is not likely I will get them back tomorrow, not even the 365 one.

And LRCX is even higher priced and also tough to buy back if assigned. With high-priced stocks it's hard to have more than a few lots, without committing too much dollar-wise in single positions. I am greedy, but also want to stay diversified.

 

[Running_Man]

My intention was not to "lose" the stocks that I was bullish on. But the premium on hot stocks was so high that the temptation was often too great to resist.

I just lost a round lot of KLAC in my account to a 355 call, then another lot of KLAC in my wife's account to a 365 call.

Immediately wrote a put at 355, and a put at 365, but it is not likely I will get them back tomorrow, not even the 365 one.

And LRCX is even higher priced and also tough to buy back if assigned. With high-priced stocks it's hard to have more than a few lots, without committing too much dollar-wise in single positions. I am greedy, but also want to stay diversified.

I will make a prediction right here, within the next three weeks a put written at 355 will fill on KLAC, of course I also think a put written at 325 might fill.

 

[NW-Bound]

Here's another opportunity for me to do a more detailed accounting on my position of KLAC to see if all this option trading does me any good. As mentioned, I usually only look at the total return of the entire portfolio. But on this stock, let's see what I have done.

I have bought and sold KLAC since pre-2000. After the tech stock meltdown in 2000-2003, I sold and did not buy it again until 2017. The following trades are only from 2017 till now.

In 2017, I bought 100 shares for my wife's account, and in 2019, another 100 shares for my account. Total basis for 200 shares: $25,770.

If I did nothing else with this position, as of today's close, at the price of $369.54, the shares would be worth $73,906, and my unrealized gain of the 200 shares would be $73,906 - $25,770 = $48,136.

With the shares assigned away last week at 355 and 365, my realized gain was $39,349 as reported by Quicken.

Why was the gain not $35,500 + $36,500 - $25,770 = $46,230?

Ah, that's because I did get calls assigned before, and had to buy the shares back, either outright or via a put. I often had to buy the shares back at a higher price than the strike price of my calls, and that reduced my gain relative to a buy-and-hold.

Then, the next question is, how much did the contracts get me? I looked it up, and from the time I established the position until now, I sold a total of 63 contracts, both calls and puts, for a total premium of $15,189.

The total realized gain at this point is then $39,349 + $15,189 = $54,538. It's better than the would-be buy-and-hold gain of $48,136, but it is not that much at $6,402. Of course, it could be more if I set the call strike prices better, or timed my share buyback better, but the above result is my actual performance.

See how hard it is compute what option trading actually gets you, compared to the alternative?

Note that because of the cost of having to buy back the shares higher, my contract premium of $15,189 was reduced to a gain $6,402. That reduction is quite significant.

 

[NW-Bound]

I will make a prediction right here, within the next three weeks a put written at 355 will fill on KLAC, of course I also think a put written at 325 might fill.

I just had two puts, one at 355 and another at 365, expire today, netting me $670 for both. This gain is included in the total premium of $15,189 reported in the previous post.

I sold another 365 put expiry Oct 1, for $5, in my account. I may sell another put next week for my wife account.

I like to sell very short options. If I am wrong in guessing the direction of the stock, the mistake is smaller and I can make a correction quickly.


PS. KLAC dropped to $350 briefly on Monday. Thought I would wait another day to grab it back, but of course I missed out as everything rebounded so quick.

At $350, I could have grabbed back both the 200 shares I sold at $355 and $365, and called it a win even if KLAC continued to drop further. The way I look at trading, whenever I could buy back something at a lower price than I sold, I beat a buy-and-hold guy. And generally, buy and hold wins in the long run, so if you beat it, you are doing even better.

 

[MRG]

Here's another opportunity for me to do a more detailed accounting on my position of KLAC to see if all this option trading does me any good. As mentioned, I usually only look at the total return of the entire portfolio. But on this stock, let's see what I have done.

I have bought and sold KLAC since pre-2000. After the tech stock meltdown in 2000-2003, I sold and did not buy it again until 2017. The following trades are only from 2017 till now.

In 2017, I bought 100 shares for my wife's account, and in 2019, another 100 shares for my account. Total basis for 200 shares: $25,770.

If I did nothing else with this position, as of today's close, at the price of $369.54, the shares would be worth $73,906, and my unrealized gain of the 200 shares would be $73,906 - $25,770 = $48,136.

With the shares assigned away last week at 355 and 365, my realized gain was $39,349 as reported by Quicken.

Why was the gain not $35,500 + $36,500 - $25,770 = $46,230?

Ah, that's because I did get calls assigned before, and had to buy the shares back, either outright or via a put. I often had to buy the shares back at a higher price than the strike price of my calls, and that reduced my gain relative to a buy-and-hold.

Then, the next question is, how much did the contracts get me? I looked it up, and from the time I established the position until now, I sold a total of 63 contracts, both calls and puts, for a total premium of $15,189.

The total realized gain at this point is then $39,349 + $15,189 = $54,538. It's better than the would-be buy-and-hold gain of $48,136, but it is not that much at $6,402. Of course, it could be more if I set the call strike prices better, or timed my share buyback better, but the above result is my actual performance.

See how hard it is compute what option trading actually gets you, compared to the alternative?

Note that because of the cost of having to buy back the shares higher, my contract premium of $15,189 was reduced to a gain $6,402. That reduction is quite significant.

+1

I recently reviewed a bunch of trades seeing my profits and they were going very well until I was ignorant about how I sould handle one situation. Seeing it in black and white(or red) is believing. Now I know what my future actions will be and how forward trading will be done. It's good to report on your actions and be prepared learn and adjust.

 

[Running_Man]

I will make a prediction right here, within the next three weeks a put written at 355 will fill on KLAC, of course I also think a put written at 325 might fill.

As of right now KLAC is at 349. Would expect that 325 still in play, but if you are looking to get the stock back in the portfolio to write additional calls against at 355 now would be the time as you could probably get a nice premium with the recent uptick in VIX and you will not have to worry about seeing 355 again for a couple of years, so it won't be called away.

 

[NW-Bound]

I hold no shares of KLAC right now, and would buy it back right now, or sell a put. However, I still have shares of other companies in this sector (semiconductor equipment), such as AMAT, LRCX, ASML, TER, MKSI. They all got hammered today. There's no hurry.

If KLAC does not get back to 355 in a few years, the whole S&P will also top out and not set new highs. KLAC has better P/E ratio, and its immediate growth prospect is good. The drawback is that this industry is highly cyclical.

By the way, my stock AA is still at 74, despite recent option assignment and outright selling. I am down a 6-figure amount today, as I write this.

 

[Running_Man]

I will make a prediction right here, within the next three weeks a put written at 355 will fill on KLAC, of course I also think a put written at 325 might fill.

Took 8 days but prediction fulfilled KLAC hit 325 this morning.

 

[Running_Man]

I expect the S&P 500 to hit 3500 by the end of October so the selling of Covered Calls should result in no loss of stock for the next few weeks. Alternatively selling puts are not reccomended as I think you will be able to pick up any stock you like for a good deal cheaper, or sell naked puts at that point.

Point being if you are thinking of selling covered calls premium should be good in the coming days so even selling right by the money might be advantageous.

 

[aja8888]

I expect the S&P 500 to hit 3500 by the end of October so the selling of Covered Calls should result in no loss of stock for the next few weeks. Alternatively selling puts are not reccomended as I think you will be able to pick up any stock you like for a good deal cheaper, or sell naked puts at that point.

Point being if you are thinking of selling covered calls premium should be good in the coming days so even selling right by the money might be advantageous.

Sounds like you are politely saying the market is about to take a 20% dive by Halloween.