Selling Covered Calls and Naked Puts

[NW-Bound]

... I'm more upset when my OTM is more OTM at expiration. Lol

When that happens, I pat myself on the back for reducing my loss with the option premium. "Look, I beat the do-nothing guy".

Quite often, the stock barely missed the strike price by a few pennies. I felt like running a victory lap.

 

[bobandsherry]

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.

[/QUOTE]
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?[/QUOTE]

For #4, if it's a stock I plan to hold long I would have encountered the loss anyway. So the premium(s) help to soften the blow.

 

[NW-Bound]

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?

You raise a very valid point with case 3. And that's why I said earlier it bothered me when one of my stocks jumped up big past the strike price. I don't want to miss out on the big gain in case 3, while still keeping the big loss in case 4.

If the big move is based on a newly disclosed stock fundamental, I will try harder to get it back.

On the other hand, as bobandsherry implied, if you sell a lot of options like I do, the many small gains are enough to more than make up for the big missed gain.

And I also do short-duration contracts, and the stock does not move up that much in a week, which makes it easier to get it back.

With short-duration contracts, the time value decay is quick, and that's where most of my gains come from.


PS. I believe that option selling has to be done in conjunction with timing on each individual stock, in order to combat the asymmetry between the outcome of cases 3 and 4. And that's what I have been trying to do.

PPS. There's a strong correlation between stocks of the same sector. Hence, I try to stagger the call options of stocks in the same sector, so that I do not "lose" them all at once due to call assignment.

 

[OverThinkMuch]

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.

Ah, that's interesting - you're not looking to keep the same stock over time. If one rockets up, it's on to the next one. Eating the loss (buying the option back) or rolling are good to have in someone's toolbox.

Another thing to consider is that buy-and-hold investors pay lower long-term taxes than turning over options many times a year. So if it's a close match, the taxes might be the final nail. But from the sound of it, you're ahead of the S&P 500 after taxes.

 

[NW-Bound]

After thinking about what bobandsherry wrote, I see that our styles are different.

I am a long-term investor at heart and use options to enhance the return. Hence, I do not want to see my shares get assigned, so that I have to buy them back.

Bobandsherry is a stock trader, and also uses options to enhance returns. He does not intend to keep the stock long-term.

Of course, we both want higher returns, but the mentality is different.

 

[bobandsherry]

Ah, that's interesting - you're not looking to keep the same stock over time. If one rockets up, it's on to the next one. Eating the loss (buying the option back) or rolling are good to have in someone's toolbox.

Another thing to consider is that buy-and-hold investors pay lower long-term taxes than turning over options many times a year. So if it's a close match, the taxes might be the final nail. But from the sound of it, you're ahead of the S&P 500 after taxes.

I don't just have one strategy. I do have stocks I definitely want to hold long, having those assigned would generate some huge capital gains. Those I put more care into ensuring I hold while still pocketing a premium. But I look for other stocks as short term, make a buck and get out. And sometimes I get involved with a stock on a short term basis and it just keeps paying a great dividend. So I just keep rolling near expiration or wait for expiration and do another CC. Holding one of those now, bought in July 2020 and still holding and rolling. 83% return / 57% XIRR right now. And I also sell puts for stocks I'd like to buy, but not at the current market price.

Being retried, I use my options premiums as part of my income cash flow. I do manage my income for taxes, and prior to this year it was much more important for ACA subsidies. But one should never make a decision simply based on taxes, or that's my take. The additional hit is only the marginal rate, but if I can make a decent return I'm OK paying a bit of that in tax

Not every option I do ends up being a winner, but more winners than losers since I started getting involved with CC, PMCC and puts after retiring (more time to pan for the hidden nuggets). And so far, very few of my stocks I've invested for CC have been a rocket. And a couple that were a rocket turned out to be a dud, so glad I let them go.

 

[bobandsherry]

After thinking about what bobandsherry wrote, I see that our styles are different.

I am a long-term investor at heart and use options to enhance the return. Hence, I do not want to see my shares get assigned, so that I have to buy them back.

Bobandsherry is a stock trader, and also uses options to enhance returns. He does not intend to keep the stock long-term.

Of course, we both want higher returns, but the mentality is different.

I am basically a long term investor. But I have a relatively small portion of my portfolio that I use to look for some "opportunities". Most of those are short term (flips) but some have then turned into long term holds as they continue to have a good overall return. So I'm more active than passive in my overall holdings. But given what you've had assigned, you then have quite a few "trades" as well. We are both similar, difference is I specifically carve out a portion for 'trades' and you end up with 'trades'.

 

[Sniggle]

My 1st 6 months of option trading are coming to a close, and it has been enjoyable and profitable, with lots of learning and quite a few mistakes. I jumped in with both feet and around $1.798 million (401K money) in July, which has grown to $1.962 million as of today ($164K gain), with 1 more week to hopefully squeeze another $5-10K. If you do the math, I am around the performance of the S & P...so not bad but I am confident that with what I learned I can do better next year.

My strategy has pretty much been the wheel, starting with CC Puts until I get assigned. I have a stable of stocks that I have gone to again and again, to include:

- AA, GS, MS, FCX, AMD, MCD, MSFT, NVDA, OKTA, AXP, F, MU, CSCO, ORCL

I have started working some of the big boys, to include GOOG and AMZN. They have generally worked well.

My biggest mistakes have been playing with new hot stocks (LMND stands out in my mind) and trying to creep up on Puts to get a little more premium (Sell a put, close that one and sell another one a little closer to the stock price, same day expiration).

I am looking forward to this next year!

(I was explaining my option trading to a nephew, and he asked my what my biggest win was. I told him I am really only interested in hitting singles, trying to make .5% a week, week in and week out.)

 

[Closet_Gamer]

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.

You're right. I did my math backwards

But I think the point holds.

You like ABC stock and would be happy to buy it at $100.

ABC is trading at $100.
You sell a put at $90 for $10.
You reserve that $10 and another $80 to cover the put if you're assigned.

The stock runs to $120.

You didn't execute a buy at $100 because you needed the cash to ensure you could cover the put option.

That share you didn't buy would now cost $120.

My point just being that if you're really interested in buy a stock, using options can still lead to unfortunate outcomes because its still market timing.

 

[Running_Man]

Closet_Gamer

My thoughts are different. First off I am not interested in stocks simply as an investment unto themselves. I am primarily interested in investments that will earn me a return of at least 3 percent over inflation. Indeed the reason I view stocks favorably is that they can reliably return such a rate over the long term.

However due to economic policy over time inflation also pushes stocks higher, so stocks tend to rise both by inflation and by actual growth. Yet puts, which therefore should be quite inexpensive as the short term risk you are investing in should be reasonably affordable as they are a sale of a financial instrument that is going against trend.

Instead I find there is a cash return of 12-15 percent that can be made on the sale of those financial instruments, where the risk is I receive a different financial instrument, that is a stock, which has an expected value in excess of my financial goals.

Basing financial investments on the emotions of regret or envy is not productive and should be eliminated. The only goal of investing should be the goal of earning a return in excess of the inflation rate over the course of your life. I am quite willing to take the exchange of a quality stock at a price less than today's quote in exchange for the rent payment on my option, however I view the right of the option as having a proven financial benefit to reaching my goal when I sell a put.

The key is I only sell puts on stocks I am quite comfortable I will reach my financial goals. And it is extremely unlikely any short term movement is going to effect my long term view on a company. And the spector of inflation is far more likely to make put buying more profitable than holding cash or any other fixed income instrument.

For example only, not a recommendation, Apple is presently selling for $176 a 160 put for Jan 28, would net $160 or 12% annual on the capital of $16,000 necessary to hold to issue the put. This money is paid immediately, which is nice even in these times of zeroish interest rates. With inflation running at 6 percent this is a 6 percent real return. I would not view being able to own 100 shares of Apple today for $16,000 as a risk. the risk would be being overweighted in total in stocks in my portfolio, so I need to keep a blend in mind.

If I was actually short in stocks in my portfolio and was much more willing to add I could sell a January 7th 172.5 put for $190. Being only for two weeks yet only a few points away from the present price, I would expect I would frequently be assigned the stock and my net purchase price would be 170.6. But if I did not get assigned the stock the annual return on my capital tie up of $17,250 is 28.63%. I do not see how either of these outcomes could possibly be a negative, if my goal was to be willing to increase my stock allocation in my portfolio.

 

[NW-Bound]

I am basically a long term investor. But I have a relatively small portion of my portfolio that I use to look for some "opportunities". Most of those are short term (flips) but some have then turned into long term holds as they continue to have a good overall return. So I'm more active than passive in my overall holdings. But given what you've had assigned, you then have quite a few "trades" as well. We are both similar, difference is I specifically carve out a portion for 'trades' and you end up with 'trades'.

Our intentions are different, but perhaps the results are the same.

I guess this is not a court, where intentions matter.

You're right. I did my math backwards

But I think the point holds.

You like ABC stock and would be happy to buy it at $100.

ABC is trading at $100.
You sell a put at $90 for $10.
You reserve that $10 and another $80 to cover the put if you're assigned.

The stock runs to $120.

You didn't execute a buy at $100 because you needed the cash to ensure you could cover the put option.

That share you didn't buy would now cost $120.

My point just being that if you're really interested in buy a stock, using options can still lead to unfortunate outcomes because its still market timing.

I normally use puts to add to a position that I already hold. If I think a stock is good at $100, then I should buy more at $90, right?

And if the put gets assigned, I wait patiently to lighten up the position with a call at $110 when the time comes.

Closet_Gamer

My thoughts are different. First off I am not interested in stocks simply as an investment unto themselves. I am primarily interested in investments that will earn me a return of at least 3 percent over inflation. Indeed the reason I view stocks favorably is that they can reliably return such a rate over the long term...

Knowing that you are a very conservative investor, I will say that you have found a strategy that suits your nature. And that's what I like about options. You can make it as risky or as safe as you like.

Investors often have this bad notion about options, the same way non-investors think of stocks as a gambling instrument. Yes, buying stocks is a risky gamble if you follow the Reddit crowd, but indexers know better than that.

 

[Closet_Gamer]

I normally use puts to add to a position that I already hold. If I think a stock is good at $100, then I should buy more at $90, right?

And if the put gets assigned, I wait patiently to lighten up the position with a call at $110 when the time comes.

Actually, my point was the opposite.

If you liked it at $100, you could just buy it and toss it into the equity basket rather than risk it moving away from you beyond the premium you picked up on the put.

You'd have a great outcome for it to be assigned at $90.

You'd have a good outcome for it to just treadwater at $100.

The outcome would be less good for it to run to $120 and not look back.

I'm not arguing against option use (I've dabbled and actually think the whole thing is quite intriguing), just noting that during my dabbling I encountered a few scenarios that weren't obvious on the surface.

I considered selling at-the-money puts under the theory that I would be perfectly happy collecting the premium and then buying the shares at the current price a few weeks later.

But then realized that in a generally bullish market, it was quite possible I wouldn't wind up buying the underlying shares at that price and the move could quite possibly out-strip my premium.

Its such a departure from my 25 year practice of simply buying, holding, and nudging my holdings back towards my AA that I need to get my head wrapped around various outcomes. Others may as well.

(Merry Christmas!)

 

[NW-Bound]

^^^^ Sure, if you really believe that a stock can do nothing but go up, then by all means buy it instead of selling a put. However, there's nothing that certain in life or in the market. We are dealing with probabilities here.

You can search and read about Kelly Criteria in betting. Basically, the optimal size of your bet depends on the probability of winning. If you are so sure of winning, then bet the whole farm.

If the probability is 50%, then there's no point in playing. You only bet if the probability of winning is higher than 50%, and then the size of your bet depends on how much larger than 50% that is.

Of course, it is hard to assess this probability, and we only have a feel for it. For example, after a hard market crash of 50% loss like what happened with the dotcom and the housing bubble, the chance of market going up is extremely high. However, before the market lost 50%, it first had to go through 10% loss, then 20%, and 30%, and so on. You don't want to jump all in at 10% drop. You have to hedge, and keep some reserve.

Back on the puts. I only hold a stock whose prospect I believe is positive. The stock price moves in the opposite direction, which I think does not agree with the stock fundamentals. I think it is likely that this drop is momentary and will reverse. However, I can never be sure. Thus, I only make a small additional bet with the put. The put premium gives me an edge here.

It is by winning several small bets that helps me. It's like the casino house that makes money by collecting a small amount each time from the gamblers, because the odds are slightly in favor of the house.

But anyway, no matter what active investment strategy one picks, it must be objectively measured against a passive indexing benchmark of the same AA. A conceptual idea is one thing, but the execution is something else. It is like cooking. You can watch a lot of cooking videos, but don't really know until you try to do it yourself.

 

[rayvt]

And if the put gets assigned, I wait patiently to lighten up the position with a call at $110 when the time comes.

Because a stock price always does what you want it to, as long as you wait long enough? Yeah, doesn't happen that way.

I am always reminded of the guy a few years back who said AAPL was overpriced at 105 and he and all his friends were going to wait until it pulled back the the reasonable price of 80-85 which it would surely do.

It never did, so he and his friends missed the run-up to the current 176.

 

[Sniggle]

Because a stock price always does what you want it to, as long as you wait long enough? Yeah, doesn't happen that way.

I am always reminded of the guy a few years back who said AAPL was overpriced at 105 and he and all his friends were going to wait until it pulled back the the reasonable price of 80-85 which it would surely do.

It never did, so he and his friends missed the run-up to the current 176.

But, at least in my mind, options are essentially Billy Ball....being satisfied to hit single after single, and drive the return to 20+% (figuring .5% a week). Taking your APPL example, if someone was assigned at 105, and then kept after it, selling puts and calls depending on what side they were on, they could have made as much as the run up would have given them.

 

[NW-Bound]

Because a stock price always does what you want it to, as long as you wait long enough? Yeah, doesn't happen that way.

I am always reminded of the guy a few years back who said AAPL was overpriced at 105 and he and all his friends were going to wait until it pulled back the the reasonable price of 80-85 which it would surely do.

It never did, so he and his friends missed the run-up to the current 176.

I stay quite diversified, and do not count on getting rich on a single stock.

If you looked at past history, and said, "If I bought XYZ here, then sold it at this point to switch to ABC, then sold ABC to go to UVW at this point, I would be a billionaire", then I would not disagree with you. Of course, what you say is correct, looking back into the past. I would just wish you good luck with the future.

As I said, as an active investor, I am happy with my performance if I do better than a buy-and-rebalance index investor. There's no point in comparing myself to a guy who happens to pick a single stock out of thousands of stocks and get rich on that single stock.

It would be like envying the guy who bought the single Powerball lottery ticket that won $878 million dollars. That envy is not constructive, meaning it does not help me get there.

Instead of hoping to get rich on a single stock, I will be very happy to get 10%-20% per year on 100 stocks. I prefer a strategy which can get me a slightly better return than indexing, and on a more diversified basis than a single stock. The chance of that is higher than with a single stock, and with a lower risk. I can still get rich, and it just takes longer but surer.

As Koolau always says, YMMV.

 

[Running_Man]

Because a stock price always does what you want it to, as long as you wait long enough? Yeah, doesn't happen that way.

I am always reminded of the guy a few years back who said AAPL was overpriced at 105 and he and all his friends were going to wait until it pulled back the the reasonable price of 80-85 which it would surely do.

It never did, so he and his friends missed the run-up to the current 176.

His friends missed nothing if they truly believed it was overpriced. There are thousands of stocks to only go with hot stocks is ludicrous. Buying financial instruments at what you have determined is a reasonable price is the single greatest road to success.

This is like someone not buying stocks and instead bought a 30 year bond yielding 14.81% for 30 years in 1981 because they saw value in a security with a real yield of over 4 percent and expected inflation to lessen because of the high interest rates. On a zero coupon bond then you paid $17.26 for a 14 percent zero bond maturing in 2011 for $1,000. Yes that is right to be a millionaire in 2011 all you needed to do was buy a zero coupon treasuries for $17,260.

Selling puts at 15% income is no different, a valuation study between the capital deployment for equity or for being willing to finance a financial contract.

And between now and the end of 2022 I suspect you will be able to purchase AAPL for under $80 a share. Just my opinion.

 

[OverThinkMuch]

Instead of hoping to get rich on a single stock, I will be very happy to get 10%-20% per year on 100 stocks. I prefer a strategy which can get me a slightly better return than indexing, and on a more diversified basis than a single stock. The chance of that is higher than with a single stock, and with a lower risk. I can still get rich, and it just takes longer but surer.

Hm, 100 stocks... buy and hold... I think you've rediscovered indexing! I'm joking - I've got dozens of stocks myself, but those are a smaller percentage of my majority passive portfolio.

Do you also diversify across sectors? (oil & gas, retail, tech, etc)
What percent of your portfolio is active stock picks?
How do you track the fundamentals of 100 different stocks?

 

[NW-Bound]

Hm, 100 stocks... buy and hold... I think you've rediscovered indexing! I'm joking - I've got dozens of stocks myself, but those are a smaller percentage of my majority passive portfolio.

Do you also diversify across sectors? (oil & gas, retail, tech, etc)
What percent of your portfolio is active stock picks?
How do you track the fundamentals of 100 different stocks?

No, I am not indexing. More like running a tiny active MF for myself. Being an active investor does not mean you abandon the idea of diversification. Real MFs with billions in assets have even more holdings, like 200 or more positions.

When my stock AA is 70%, about 60% is active stock picks and sector ETFs. The remaining 10% is active MFs that I bought a long time ago but have not gotten around to liquidate. Part of the reason I keep them is to see how they do. There's Wellesley and Wellington in the MFs too, and these are there to stay.

Yes, I have positions in many different sectors, but have heavy concentrations in sectors that I like. I buy and hold them until I think their prospects change, or that they have topped out and become overvalued. I like growth stocks a lot, but will not pay for sky-high P/E, or buy stocks with potential for growth but yet have no sales.

Yes, it takes some time to follow the stock fundamentals. It would not be possible without the Internet. Most of the time, I don't pay attention to a stock unless its price shows a big change. Then, I look into it to try to understand the reason. Quite often, there is no discernible fundamental change to me. That's when I look into selling calls or puts on them. My option selling is more a reaction to the short-term stock movements which I don't think are rational.

 

[OverThinkMuch]

No, I am not indexing. More like running a tiny active MF for myself. Being an active investor does not mean you abandon the idea of diversification. Real MFs with billions in assets have even more holdings, like 200 or more positions.
...
Yes, I have positions in many different sectors, but have heavy concentrations in sectors that I like. I buy and hold them until I think their prospects change, or that they have topped out and become overvalued. I like growth stocks a lot, but will not pay for sky-high P/E, or buy stocks with potential for growth but yet have no sales.

Your own personal mutual fund, that makes sense. And I get diversifying, I was just curious how you draw the line. When I bought individual stocks in 2020, I made sure to buy from various areas of the economy. I felt like I was creating my own index fund - but to spread risk around, that's a good thing (risk in that case was bankruptcy risk, which didn't materialize but was already factored into my expected returns).

 

[Running_Man]

If you want to sell puts, premiums are high today!

 

[aja8888]

If you want to sell puts, premiums are high today!

High prices paid to catch a falling knife.

 

[Sojourner]

If you want to sell puts, premiums are high today!

Yep, great timing for us monthly put sellers. I just sold a handful of Feb 18 puts for a grand total of $2,900. Now I need the markets to go back up a little so I can sell some calls tomorrow!

 

[Rowej]

Well if anyone did it today, they were rewarded by the end of the day! WOW,.. what a reversal today.

 

[aja8888]

I sold a Ford put today expiring on the 28th just before things headed north. Only 1,000 shares @ $18.50 and netted me $380.00.

I've done the Ford put several times for a year now and only took the stock one time and then unloaded it thru a covered call.

I guess the FED Put Protection Team was at work in the background today!