Selling Covered Calls and Naked Puts

[Running_Man]

When people talk about their cash being a dead weight on the portfolio, I keep saying mine is not. Heh heh heh...

I usually commit about 10-30% of my cash, and the return when averaged over the entire cash portion is not bad at all. Heh heh heh...





Of course, there's risk and one has to know how to control it. Same as what I do, Running_Man and Sojourner only commit a portion of their cash to cover put options. And if the market drops 50%, we lose money, but it is still not as bad as someone who buys/holds the same stocks.

The stock buy-and-holder may win out when the stock goes to the moon. Maybe he will make 10x, while we only collect the small option premium. But then, I am not holding my entire stash in cash for writing put options. I own plenty of stocks too. Remember that I am only doing this on the cash portion of the portfolio, and then only on part of that cash.

And this is why I repeatedly said I don't bother to hold bonds. I think that bond return is low and the reward is lousy compared to the risk/reward of doing cash-covered put options. But then, this requires some market watching to sell options only on market down days. Yes, it takes some market timing.


PS. People will say, if it is so easy then why big investors don't do it. They know about all this, but being of their size, they cannot do the small hit-and-run that I do. They do big option and future trading on the S&P, but options of many individual stocks do not have the high volume for them to mess with.

It's like you can buy one or two foreclosed homes to flip, but that's peanuts for Buffett and he will have to look to buy an entire town and he cannot do that without people noticing.

Well stated!

 

[street]

Thanks NW-Bound.

 

[OverThinkMuch]

When I invest actively, I track my performance against a benchmark. Do those selling calls track their performance against say the S&P 500?

If it gets assigned, then I just do a put. Buy back on the dip. Overall I'm ahead of the game.

Most stocks go up over time - what happens for that common case, when the stock never falls back into the range of your put?

It's good to track performance against the S&P 500, if that's what you mean by the game.

 

[NW-Bound]

Selling OTM call and put options is like selling lottery tickets. You collect $1 for each ticket that pays out $2 or $3 once in a while to the ticket holder.

You get to decide the chance that the ticket will pay out. The smaller the chance, the less money you can sell the ticket for.

The difference with real lottery tickets is that there's no grand prize of million of dollars. Else, you could go broke as the ticket seller.

 

[NW-Bound]

When I invest actively, I track my performance against a benchmark. Do those selling calls track their performance against say the S&P 500?

Most stocks go up over time - what happens for that common case, when the stock never falls back into the range of your put?

It's good to track performance against the S&P 500, if that's what you mean by the game.

I do, and talk about this often elsewhere on this forum.

Basically, with a stock AA in a range of 65% to 80% using tactical AA, I manage to match or beat a guy who is 100% in the S&P.

Of course, there is no guarantee this will continue, but so far so good.

Here's a chart computed by my brokerage and captured off my screen, that I shared elsewhere. This includes the accounts where I did all of my option selling, and encompasses 70% of my investable assets.

Note that the 30% of my investable assets not reflected in this chart has a lot of low-return assets such as I bonds and stable value funds. Hence, my total portfolio return is not as good as this chart, but still higher than an AA of 65-80% stock.

 

[Running_Man]

There is nothing "magic" about selling options. It's not free money, even though it may appear to be for a period of time.

There is no free money to be had in the stock market. You are just putting on a risk that you are perhaps not aware of.

When the market turns against you, options can rip your face off.

It is true there is no magic to options, it comes down to basic math. Individuals are willing to give up between 13-17% annually of their gains for the comfort of being able to sell at a lower than market price in the future, in a market with 9% long term average returns. So the people that I am selling puts to are willing to accept on average -4 to -8 percent expected returns in exchange for comfort, or perhaps to delay a tax bill, in any case it is the option seller who is paid that tab. Stated another way an option seller is being rewarded by 4 to 8 percent over expected market returns in exchange for being willing to buy the stock in the future for a price lower than what the market, with all known information states the stock is worth today.

On covered calls there is no risk, it is only a lowering of potential rewards. On a stock like Tesla, if I did own that stock, I could make 1 percent a week on a call option 10% higher than the price today due to the high volatility of Tesla stock. And this for a stock that is worth 5% of the GDP of the United States, 33% of Germany's GDP. I guess the value of Tesla is just very subjective, at an implied cost of 52% annually just to be able to buy it after it makes a stock price increase equal to 1% over the average long term annual market return, in a single week. Individuals are renting the potential excess gains of your ownership in Tesla for an interest rate of 52% annually in exchange to limiting their losses to 52% of the price of Tesla over the course of a year. Yes there is a potential cost but I think the rent covers it.

Full disclosure I have not done this with Tesla because I do not believe Tesla is worth 5% of the GDP of the United States and I don't see it growing to 7-8% of GDP of United States in the coming months. I am just showing how very expensive renting gains in stocks can be via the purchase of a call option.

 

[street]

Very interesting stuff.

 

[NW-Bound]

Very interesting stuff.

Yes. It's not like playing the one-armed bandit, which day trading often is.

Yes, there's risk, but if you own stocks, you are already accepting some risks. The question then is what is the risk/reward profile of this strategy, compared to the passive indexing using a fixed AA. Again, you get to decide how risky or safe you want to be.

 

[MRG]

When I invest actively, I track my performance against a benchmark. Do those selling calls track their performance against say the S&P 500?


Most stocks go up over time - what happens for that common case, when the stock never falls back into the range of your put?

It's good to track performance against the S&P 500, if that's what you mean by the game.

I do this as a replacement for my cash. I started because I had a CD paying 2% annually mature. Couldn't find any to replace it so now my goal is 1% weekly.

 

[NW-Bound]

On covered calls there is no risk, it is only a lowering of potential rewards. On a stock like Tesla, if I did own that stock, I could make 1 percent a week on a call option 10% higher than the price today due to the high volatility of Tesla stock. And this for a stock that is worth 5% of the GDP of the United States, 33% of Germany's GDP. I guess the value of Tesla is just very subjective, at an implied cost of 52% annually just to be able to buy it after it makes a stock price increase equal to 1% over the average long term annual market return, in a single week. Individuals are renting the potential excess gains of your ownership in Tesla for an interest rate of 52% annually in exchange to limiting their losses to 52% of the price of Tesla over the course of a year. Yes there is a potential cost but I think the rent covers it.

Full disclosure I have not done this with Tesla because I do not believe Tesla is worth 5% of the GDP of the United States and I don't see it growing to 7-8% of GDP of United States in the coming months. I am just showing how very expensive renting gains in stocks can be via the purchase of a call option.

Tesla stock options carry a huge premium. This by itself would not deter me, in fact should be very tempting. However, the stock fundamentals I don't like, and the valuation is all out of whack. It does not compute. And one random Twitt by the CEO would send you reeling.

For the same reason, I am not at all interested in playing the game that the Reddit crowd does, with their meme stocks like GME, AMC, KOSS, etc..., or even bet against them (too risky).

No IPO, no stock with stratospheric P/E, no unproven life-changing stocks (or do they call that "disruptive" technologies). The only life the stock may change is mine, and not in a good way. I am more comfortable with the risks that I know better, and I already make enough.

 

[steelyman]

My only experience with options was selling covered calls and cash-covered puts in a taxable brokerage account. I decided it was too much work especially when it came to tracking things for tax purposes so I stopped.

I recently had a newish Roth IRA approved for limited margin trading (Fidelity) and have a toe back in the water but only with similar very conservative moves. I figure it’s a way to bring more cash into the account beyond the restrictive annual contribution limit.

 

[conversationalphrase]

I am late to this game but let me see if I'm understanding correctly:


Selling covered calls:
I own the stock and think it may not appreciate to the strike price that I sell my call at. There are three possible outcomes:

1. I get whatever price I can for the call and assuming I'm right on the strike price that's money in the bank when the option expires.
2. If the stock price does increase above the strike price, then I will get assigned on the option date and have to sell my shares at the strike price
3. I can buy back the call before expiration and take a loss equal to the difference between my option selling price and my buy back price.

I'm not clear exactly how outcome #3 would structurally work.


Selling cash covered puts:

I don't own the stock and think the stock price is not likely to decrease to the strike price that I sell the put at. I need to put aside an amount of cash equal to the strike price * number of contracts * 100, in case the put gets assigned. This is also my maximum loss in the case the stock price goes to zero. The outcomes are:

1. The stock price does not decrease to my strike price and the money I sold the puts for is profit to me on the expiration date of the option.
2. The stock price does decrease to my strike price and I have to buy the stock at that price.
3. The stock price decreases to my strike price, but I buy back my put before it expires. My loss it the difference in option price when I sold versus when I bought it.

What do I have wrong?

 

[MRG]

I am late to this game but let me see if I'm understanding correctly:


Selling covered calls:
I own the stock and think it may not appreciate to the strike price that I sell my call at. There are three possible outcomes:

1. I get whatever price I can for the call and assuming I'm right on the strike price that's money in the bank when the option expires.
2. If the stock price does increase above the strike price, then I will get assigned on the option date and have to sell my shares at the strike price
3. I can buy back the call before expiration and take a loss equal to the difference between my option selling price and my buy back price.

I'm not clear exactly how outcome #3 would structurally work.


Selling cash covered puts:

I don't own the stock and think the stock price is not likely to decrease to the strike price that I sell the put at. I need to put aside an amount of cash equal to the strike price * number of contracts * 100, in case the put gets assigned. This is also my maximum loss in the case the stock price goes to zero. The outcomes are:

1. The stock price does not decrease to my strike price and the money I sold the puts for is profit to me on the expiration date of the option.
2. The stock price does decrease to my strike price and I have to buy the stock at that price.
3. The stock price decreases to my strike price, but I buy back my put before it expires. My loss it the difference in option price when I sold versus when I bought it.

What do I have wrong?

Nothing except you can "Roll" options forward and continue making premiums. For example I have been playing puts on AMD for several months. At one time I was going to be assigned the stock but chose to roll my in the money put forward and in a couple weeks the put was out of the money and expired worthless.

 

[Sojourner]

Nothing except you can "Roll" options forward and continue making premiums. For example I have been playing puts on AMD for several months. At one time I was going to be assigned the stock but chose to roll my in the money put forward and in a couple weeks the put was out of the money and expired worthless.

How exactly does this work? AFAIK, the only way to avoid being assigned an ITM put is to buy the put back, which requires an immediate outlay of cash. You're saying that "rolling" allows you to extend the expiration date without forking over any cash, or something like that?

 

[finnski1]

Nothing except you can "Roll" options forward and continue making premiums. For example I have been playing puts on AMD for several months. At one time I was going to be assigned the stock but chose to roll my in the money put forward and in a couple weeks the put was out of the money and expired worthless.

Yes but that doesn't eliminate his scenario number #3. You have to close out the initial put by buying it back most likely at a loss (the put would cost more because it is getting closer to strike price)) so that you can simultaneously sell a new put at the later expiry and collect a new premium that hopefully offsets your loss. This scenario could keep continuing and you keep buying back the put at a loss (if the stock keeps going down) and thus amplifying your losses. No sure thing.

 

[finnski1]

How exactly does this work? AFAIK, the only way to avoid being assigned an ITM put is to buy the put back, which requires an immediate outlay of cash. You're saying that "rolling" allows you to extend the expiration date without forking over any cash, or something like that?

No. You have it right and I don't think he was saying there was no cash outlay, just that you can avoid being assigned the stock by buying back the put(at a loss of original selling premium) in hopes that the second time works in your favor.

 

[Closet_Gamer]

Selling cash covered puts:

I don't own the stock and think the stock price is not likely to decrease to the strike price that I sell the put at. I need to put aside an amount of cash equal to the strike price * number of contracts * 100, in case the put gets assigned. This is also my maximum loss in the case the stock price goes to zero. The outcomes are:

1. The stock price does not decrease to my strike price and the money I sold the puts for is profit to me on the expiration date of the option.
2. The stock price does decrease to my strike price and I have to buy the stock at that price.
3. The stock price decreases to my strike price, but I buy back my put before it expires. My loss it the difference in option price when I sold versus when I bought it.

What do I have wrong?

I think there is a question of how much you want to own the stock in question.

If you're actually intending to buy and hold the stock, you do take on the risk that the stock runs long but you couldn't buy it b/c you had to hold the cash to cover the put.

For example, ABC is trading at $100.

You sell a put at $110 for $10, reserving and additional $100 of cash to cover the put in case the stock drops and you have to buy the shares for $110.

Stock runs straight to $120 and doesn't look back.

You're now in possession of a $110 to buy a $120 stock that you actually wanted.

Just a scenario to consider depending on your objectives.

 

[bobandsherry]

Well, I have "lost" a few hot stocks, when they surge on good news to way above my strike price. Yes, I make money, but not as much as a buy-and-hold guy. Needless to say, I don't like this a bit.

I usually watch the stock, and often sell a put option at the same strike price or slightly higher further out in the future in order to get it back. If I keep doing it, will slowly catch up with the stock and own it again. Or it may come down along with the market in a correction, back to where I sold.

I know you are deep into options, trading a higher volume than me, so you probably have a bigger chance to more being "lost". For me, I don't focus on "a few", I look at the bigger picture. How much more have I pocketed vs if I did nothing. I'm OK with a few being "lost". But I have very few that are really "lost, just wait for the next opportunity.

Funny thing is, for every "lost" there is a new "found" opportunity. I can look for another stock to invest in. Or I can stick with same stock and sell puts at the price I wanted. If stock drops, I'm back in. If not, keep doing puts and hopefully stock settles to a point where I can use premiums to offset the higher cost and start all over again. If it never comes back, I go back to my original philosophy, don't focus on one or a few that got called, just look at the bigger picture and if I'm ahead of the game I'm happy. If not, then it would be time to re-evaluate my strategy.

Happy investing.

 

[conversationalphrase]

I think there is a question of how much you want to own the stock in question.

If you're actually intending to buy and hold the stock, you do take on the risk that the stock runs long but you couldn't buy it b/c you had to hold the cash to cover the put.

For example, ABC is trading at $100.

You sell a put at $110 for $10, reserving and additional $100 of cash to cover the put in case the stock drops and you have to buy the shares for $110.

Stock runs straight to $120 and doesn't look back.

You're now in possession of a $110 to buy a $120 stock that you actually wanted.

Just a scenario to consider depending on your objectives.

Wouldn't I want to sell the put at less than the current strike price, i.e. $90 not $110? Or looking at it another way, if I like the stock at $110, then I should just buy it at $100 if that's the current price.

 

[MRG]

No. You have it right and I don't think he was saying there was no cash outlay, just that you can avoid being assigned the stock by buying back the put(at a loss of original selling premium) in hopes that the second time works in your favor.

Right except forgot about the loss. Your roll generates a credit to your account and you received a premium on the initial sale. It's taken me a while to wrap my head around this, and point out what I'm missing please. This works until it doesn't, if the underlying equity falls or rises significantly it probably fails, or becomes less profitable.

When I have rolled options forward in some cases the brokerage sells the new put before buying back the old. Others It's a buy back then a sell.

 

[Sojourner]

I think there is a question of how much you want to own the stock in question.

If you're actually intending to buy and hold the stock, you do take on the risk that the stock runs long but you couldn't buy it b/c you had to hold the cash to cover the put.

For example, ABC is trading at $100.

You sell a put at $110 for $10, reserving and additional $100 of cash to cover the put in case the stock drops and you have to buy the shares for $110.

Stock runs straight to $120 and doesn't look back.

You're now in possession of a $110 to buy a $120 stock that you actually wanted.

Just a scenario to consider depending on your objectives.

Hmm. That's not how I sell puts on stocks I want to own. I always sell slightly OTM puts, with the expectation that (eventually) the stock will drop and I'll pick it up at a discount, meanwhile collecting options premiums on the OTM puts I'm selling.

I'm not sure I understand why you'd sell a heavily ITM put on a stock you want to own. ATM, yes (to collect a much larger premium) but 10% ITM? Wouldn't that (usually) lead to the stock being put to you at a higher price than you would've paid when you sold the put? Selling slightly OTM puts seems like a better strategy, since you'll generate options income and eventually own the stock at a discount.

 

[bobandsherry]

When I invest actively, I track my performance against a benchmark. Do those selling calls track their performance against say the S&P 500?


Most stocks go up over time - what happens for that common case, when the stock never falls back into the range of your put?

It's good to track performance against the S&P 500, if that's what you mean by the game.

Agree, most stocks go up over time. But most stocks also ebb and flow, very few have a straight up trajectory. So there's a couple strategies I use.

• First, you could buy back the option and keep the stock. I usually will not do that, but depends on the situation.
• Or I could roll the option, basically buying back the and selling another at a longer expiration. Works if there's a sudden pop in the stock and it settles back down.
• But sometimes that doesn't work if stock has really moved, so in that case I'll sell a put at the price I want to pay (prior option strike price most likely). May take a while, and I just keep collecting the premium. If stock never drops, I can buy back the stock and the premiums I collected then help to offset that additional cost.
• Or stock just rockets and I shrug my shoulders, realize I made a decent return and look for the next rocket.

As for being ahead of the game, I use the S&P to benchmark if my individual investing is doing better than it's return, if not, then I should just dump my money into the SPY and call it a day. But for my options, I track my options and determine if I'm ahead of the game if I did nothing (just buy and hold for example). When it's negative, I then know I need to stop doing options.

BTW, doing covered calls has opened me up to some stocks I wouldn't have invested in but trade short term to take advantage of the volatility (and with very short expirations). If those get assigned I'm 100% OK as I only invested in those with an expected assignment and high return. As an example, just last week, $36 stock that I could by a $35 strike and collected $6 premium. Held it for 4 days. Can't complain about $5 net premium on a $30 net investment for under a week. Funny thing is, it closed at $37.26, so I felt good. But this week it popped, trading now at $53. I was still OK as I made this as a trade, wanting it to be called as I was investing some short term cash I had sitting idle. I also sold puts, so did alright on trades of less than a week.

 

[NW-Bound]

I know you are deep into options, trading a higher volume than me, so you probably have a bigger chance to more being "lost". For me, I don't focus on "a few", I look at the bigger picture. How much more have I pocketed vs if I did nothing. I'm OK with a few being "lost". But I have very few that are really "lost, just wait for the next opportunity.

Funny thing is, for every "lost" there is a new "found" opportunity. I can look for another stock to invest in. Or I can stick with same stock and sell puts at the price I wanted. If stock drops, I'm back in. If not, keep doing puts and hopefully stock settles to a point where I can use premiums to offset the higher cost and start all over again. If it never comes back, I go back to my original philosophy, don't focus on one or a few that got called, just look at the bigger picture and if I'm ahead of the game I'm happy. If not, then it would be time to re-evaluate my strategy.

Happy investing.

I do not disagree with you. I stay quite diversified, and do not count on getting any 10-bagger to get rich on just one stock "going to the moon". Therefore, "losing" one good stock due to a call getting assigned should not impact my total return that much.

It bothers me mainly because I only hold stocks I want to own long term. If I sell a stock, it should a deliberate trade. My intention for the call options is for them to not get exercised. When one gets deep in-the-money, it means my anticipation was off, and when several calls get hit, that can, emphasis on can, lower my return below that of doing nothing.

By the way, the options when I sell usually have a delta of 0.2 or less. But I have found by downloading and analyzing my record is that the rate of assignments of my options is around 30%. This means my timing of the market trend needs some improvement.

 

[bobandsherry]

I do not disagree with you. I stay quite diversified, and do not count on getting any 10-bagger to get rich on just one stock "going to the moon". Therefore, "losing" one good stock due to a call getting assigned should not impact my total return that much.



It bothers me mainly because I only hold stocks I want to own long term. If I sell a stock, it should a deliberate trade. My intention for the call options is for them to not get exercised. When one gets deep in-the-money, it means my anticipation was off, and when several calls get hit, that can, emphasis on can, lower my return below that of doing nothing.



By the way, the options when I sell usually have a delta of 0.2 or less. But I have found by downloading and analyzing my record is that the rate of assignments of my options is around 30%. This means my timing of the market trend needs some improvement.

I've had to work my way out of an assignment once or twice this year. Everything else that was assigned was ok by me. I'm more upset when my OTM is more OTM at expiration. Lol

Market has been frothy and exuberance has caused some to move more than we might expect. Sorry to say, but next year the market may be less frothy and you may improve on the slugging% for stocks that get assigned. The downside is it will also impact the overall profitability of options too. Good luck in the new year!

 

[rayvt]

I am late to this game but let me see if I'm understanding correctly:

Selling covered calls:
I own the stock and think it may not appreciate to the strike price that I sell my call at. There are three possible outcomes:

What do I have wrong?

No, you've made the classic mistake that cover call proponents continually make.

There are four (4) possible outcomes:
1. stock goes up a little.
2. stock goes down a little.
3. stock goes up a lot.
4, stock goes DOWN a lot.

In cases 1 & 2, you make a small amount of money, and keep the stock. In case 3 you make a small amount of money, but give up a large part of the gain.
In case 4 you make a small amount of money on the premium, but lose a large amount of money on the stock loss.

The thing is, you need the occasional large profits (step 3) to offset the occasional large losses of step 4. But you've chopped off the large gains. Look at the P&L chart for covered calls. You keep a small about of the upside, but fully participate in the downside.

But, CC proponents ignore the case 4 (as you did in listing what you thought were the 3 possible outcomes). And they tend to say "Well, if that happens I will just sell the stock before it tanks." As if. Because everyone knows that it is easy to predict when a stock will tank, right?

"There are treacherous conditions in which the benefits are frequent, small and visible -- and the costs are large, delayed and hidden. And, of ocurse, the postential costs are much worse that the cumulative gains." Nassim Taleb writes in Anti-Fragile