Covered call/naked put writing on ETFs?

[Olav23]

Hi all,

Just was wondering if anyone had any experience selling covered calls and naked puts on ETFs (huhuhuh I love the lingo!)

I am reading a book called something to the effect of "Be your own hedge fund" and the basic premise is to sell naked puts and write covered calls at the money. Covered calls giving you a bit of downside protection as well as income and naked puts because you want to theoretically own the underlying ETFs anyway if it gets exercised on you.

The premise is that it lowers your volatility quite a bit, but you miss out on part of the large quick up swings.


Just wondered if anyone had given it a shot...
Olav

 

[brewer12345]

To thoughts:

1) You had better really understand what you are doing before you try it. Options can be a great way to blow yourself up.

2) The main problem for these types of startegies for a retail investor is that the spreads in often illiquid option markets and the other transaction costs can kill any extra return you might generate.

Not worth the trouble, IMO.

 

[Olav23]

1) I wholeheartedly agree. I believe these two strategies are known as "conservative" strategies, as they are usually very close to AT the money when sold so, its basically a hedge as opposed to a speculation play.

It's purely used for short term income and it's on ETFs that you plan on purchasing anyway. (for the naked put) Or re-purchasing the ETFs at expiration if you get exercised and lose your ETFs (for the covered call).

2) I think this is helped by the fact that its usually the bigger ETFs (SPY, QQQ, etc) with high volume, and the high volume usually transfers to high volume on the at the money options. But your point is well taken!

I might give it a shot on a couple k and see how it does and report back.

Thanks!

 

[JPatrick]

I sell covered calls frequently.  As I type, I have orders in to sell August calls on my DVY and QQQQ.
Option premiums have really fallen apart the past few years, but now appear  to be coming back.
As you know, with options you must be ready to accept what your trade gives you.  When I sell my calls I must be ready to give up my stock without tears (Iam) and I need a plan should the stocks drop while I've got a call out (in the case of DVY/QQQ) I'll just ride it down cause I'm 99% sure they will be back.
If you want some solid info on the subject visit optionetics.com or read books by George Fontanills.  Unfortunately, most of the good stuff on the website is in the pay pages.

 

[Olav23]

Thank you for the info. I was starting to think that I was alone in looking into options here!

Dave, could you explain in a bit more detail what you mean by " This is a better time to take some riskier positions and cover them with some cheap options." Do you simply mean buying the stock outright, and buying a put as well to protect from the downside? (like an insurance premium?)

Also, interesting that you mention the VIX. I am looking at a graph here:
http://finance.yahoo.com/q/bc?s=^VIX&t=5y

It certainly looks headed down and hasn't been above 20 for at least a year and looks headed even lower! Since the VIX is based on the S&P 500, I wonder if its comparable to the SmallCap/Emerging Markets/REIT index ETFs. You'd imagine there would be more volatility there! What's your thoughts on this?

JPatrick, have you gauged your returns using the covered call strategy over the outright buying and holding? Has it proved to work better? Have you also considered using a naked put strategy as well? Then if you get exercised, do the covered call? I believe this works out to be the same as far as risk profile, except you get the added bonus of the extra cash in the account without owning the security... (though thats a 2-edged sword!)

 

[lazyday]

If option prices are too low today, I wonder if it makes sense to just buy the calls.

Seems I've been reading everywhere how great it is to sell covered calls, and that there's several new exciting offerings of funds that do just that.
I was even at a lunch where someone next to me was touting the strategy, which she got from someone who advertises on the radio. She said it almost guarantees a high return in good and bad markets.

With all this coverred call selling, maybe it makes sense to buy.

(To be honest, I really am not interested in buying. I've never messed with options, and it would take something fairly extreme to make me start, as I don't feel like travelling up the learning curve, or competing with hedge funds and others. Just making conversation. )

 

[LOL!]

I've sold covered calls for about 2 years now ... maybe 5 - 10 times a year. In that time, I have made a little money, but not much doing so. I have a spreadsheet that gets stock and option quotes and lights up "green" when it makes sense to write a call. "Makes sense" to me is a call that will net at least 1-2% over the course of a month. I've had calls expire, calls exercised (getting my underlying stock called away), and had to buy back calls when I decided the stock was more important to me. I have also bought stock specifically in order to sell a call. I try to sell calls that are at least 5%-10% out-of-the-money and net 1-2% in premium, so that if the call is exercised, I have a 6% to 12% gain in one month.

The situations do not occur often with the kinds of stocks that I own, so I don't think you can expect to make this amount every month.

Also once you sell the call, if the stock share price drops and you want to sell, then you have to buy back the call ... or just let it expire. But you cannot sell the stock while the call is hanging over it. Also if the stock goes up past the strike price, I feel really bad that I miss out on those gains.

I have also bought calls. Unfortunately, I lost money on because I was greedy ... the call would have doubled my money if I had sold it within a 1 or 2 hour time frame. So I think you have to watch the market or set limit orders to get acted upon ahead of time.

And of course you have to remember that someone has to buy the call from you. Folks don't buy calls that have no chance of making money for them. You can see only a handful of options have any kind of trading volume at all. That is, they are not as liquid as the underlying stock.

 

[Olav23]

Its also worth considering as opposed to writing covered calls, writing naked puts. Some brokerages don't allow it, but if you want to own a stock ANYWAY, you get to use the leverage of the option without tying up the cash. Though, remember, if you are exercised, you need the cash available to purchase the underlying stock. Hence, the strategy I was reading about was basically:

1. Sell naked put. Collect premium
If it expires worthless, you collected premium.
If it is exercised, you purchase the stock you wanted anyway at a discount (price paid - premium received) and then immediately write a covered call.
If this covered call gets exercised, you get your stock called away and immediately go back to 1.

Basically selling naked put and covered call are the exact same risk profiles, except your money is not tied up in the naked put and you don't have to pay the stock commission on top of the option commission.

Here is a good example, but instead of pure stock, this would be with Index ETFs.

http://www.valueline.com/edu_options/rep4.html

 

[Olav23]

Ahhh.. very good point! DAMN YOU BLACK-SCHOLES!!

I think it just makes me a bit uncomfortable selling naked calls. The thought that I have the possibility of unlimited risk for a maximum upside potential just doesn't sit well for me. I live by the theory that if the chances are 50/50, I will be wrong 100% of the time.. Call me a cynic!

I am not sure if i mentioned it, but my experience is all theoretical. So you have a lot more experience than I do obviously.... Just was fishing for ideas if I should look into this strategy, and being that a few people DO use options strategies, it sounds like something I should explore further...

Thanks for all the help!