Writing Options for Income

[TallTim]

Two good discussions started by Utrecht here:

http://www.early-retirement.org/forums/f44/lets-discuss-some-real-time-option-trades-59135.html

http://www.early-retirement.org/forums/f44/anyone-here-trade-options-57450.html

He may chime in later if around.

 

[clifp]

I am a fan of this strategy. I believe it is an alpha-generator. Because of the demand for S&P 500 puts, they tend to be overpriced - the implied volatility of the put sold tends to be greater than the subsequent realized volatility. Over time this is the source of the alpha. It is very easy to implement, so I would suggest you do it yourself rather than pay part (or all) of your alpha to a manager.

We have a forum member named utrecht who did this strategy quite successfully with slightly out-of-the-money weekly SPY puts. There is a lengthy thread on the subject. Maybe someone can post a link.

I also write a modest number of covered calls and cash-secured puts.

I think it does generate alpha for the reason FIRE mentioned but also because reduced portfolio volatility is so valuable to a retiree.

A very crude approximation of the stock market returns will look like this.
Year 1 +40%
Year 2 +20%
Year 3 -20%
Year 4 +10%
Year 5 -0
Averaging about 10%/year.

If you employ options writing on a portion of your a portfolio and get 5% premium/year, you'll make less money in good years, lose less in bad years and break even in the relatively rare normal years.
So your returns might look this.
Year 1 +35%
Year 2 +15%
Year 3 -15%
Year 4 +10%
Year 5 +5%
Still 10% a year.

For a 25-year-old with say 25-30 years ahead of them the sequence of returns doesn't matter that much, and the higher volatility is your friend. (i.e dollar cost averaging). In fact, when you consider the fairly high transaction cost for writing options, the huge number of professional with advantages of sophistication,and speeds (e.g.high free traders/Flash boys) it probably doesn't make sense for a young person to do this.

However, for retired folks I think it helps. . I don't need 30% up years in my portfolio so if I only make 20% during this bull markets I am ok with that. What I need to avoid is a long string of 0 to negative years.

I also find that option writing is counter cyclical, I personally pay attention to the VIX when it is above 20, I write a lot of puts. When it is 15 or so, I'm pretty selective (I have 200K in a IRA that I write cashed secure put on monthly basis), but don't write many other options. When it gets close to 10, I just stop writing all together. This works out well for me, because when we are in a real bear market, I write more options than in a bull market.

 

[Running_Man]

Seven Myths about Stock Options



I'd add to that question "How much profit did the option seller forego on the 10% options that were exercised?"

Opportunity costs are still real costs.

It is hard to say, how many of those were deep in the money calls that were used as a proxy for stocks? In those cases none as I assume the covered call writer would select out of the money calls. In how many cases would the option seller have sold the stock anyways at a selected price? If you buy an individual stock you should have an idea of at what price you would sell it. If it is far away in price then I would not advise writing covered calls against it, but if a stock is coming close to your selling point then a covered call will optimize your decision and provide a little extra income.

The exact same strategy works on purchases, if you were looking for Exxon last year to hit 75 when it was trading in the low 80’s you could sell a 75 put for the amount of shares you were willing to take and when XOM fell to 70, you get put in @ 75, less the option premium. If it never hits 75 you don’t get in, same as if you were going to buy the stock but you collect the premium. Overall if executed properly you save money over time, you do not lose money.


For instance I owned Hormel and decided from looking at the stock that at 44-45 I was going to sell HRL because the dividend yield percentage would have fallen beneath my minimum. I could have a covered call @ 45 and would be automatically taken out of my stock at my predetermined price, if not I pocket the option. If instead along the line I decide I should sell HRL then I buy the option back and close the stock position.

 

[Gone4Good]

In how many cases would the option seller have sold the stock anyways at a selected price? If you buy an individual stock you should have an idea of at what price you would sell it.

No doubt. And this seems like a reasonable use of covered calls. But that's not my understanding of what's being discussed.

Folks are talking about writing covered calls as an income strategy. In other words, systematically and continuously writing calls against stocks you intend to keep.

 

[Totoro]

Asked Utrecht to weigh in with his latest experiences, thread was really interesting (last post was 2013).

So, please keep sharing thoughts and experiences

 

[ERD50]

Go here:

http://stockcharts.com/freecharts/perf.php?SPY,$BXM,VWIAX

select "all" on the slider - the Buy-Write Index seems to do as intended, reduces volatility, does well, but lags in a fast rising market.

But it sure is tough to beat Wellesley!

-ERD50

 

[clifp]

Go here:

http://stockcharts.com/freecharts/perf.php?SPY,$BXM,VWIAX

select "all" on the slider - the Buy-Write Index seems to do as intended, reduces volatility, does well, but lags in a fast rising market.

But it sure is tough to beat Wellesley!

-ERD50

I have to admit, while I'm pretty confident of my ability to generate Alpha. My confidence of my ability to generate more Alpha than Wellesley diminishes each year.

 

[Totoro]

VWINX doesn't look so hot to me from this comparison:

What am I missing?

 

[Senator]

I have written a lot of covered calls. It works, until it doesn't. You will likely never go broke selling covered calls. Worse case, you sell the underlying issue at a discount to someone else. They work best in sideways or down markets.

Have a set strategy. Here are a couple that work for an investor that want to expand their portfolios.

Write a buy/write call for $1 over the price of the S&P, like IVV or VOO. If IVV goes up, the shares will get taken away at a profit. That works.

If IVV doesn't go up, you own it at a discount due to the call you wrote. You are increasing your portfolio, so it just gets added to the bucket.

Sell puts at $1 under for the same stock, like IVV. If you were going to buy the stock anyway, why not sell the put instead. You will either own it at a discount, or just taken in a premium.

Another twist...
If you sell covered calls, put in a buy order of the same issue at a 25% discount right away. At some point, the stock will usually bounce around and hit the price. Pick up a 25% gain in a few days. It may only be $25 or so per contract, but it's money.

All of the above is a bit more work that I like to do these days....

 

[ERD50]

VWINX doesn't look so hot to me from this comparison:

What am I missing?

Dividends!

The chart I linked includes the effect of reinvesting dividends. The chart you used is NAV, dividends not considered at all.

Total Return is what matters. You can also go to yahoo "adjusted" price history for that.

~2.9% divs versus ~ 2.1% divs will add up over ten years.

-ERD50

 

[Totoro]

Cool, thanks for the clarification.

Checked morningstar TR to compare. On 10y same performance but alot less volatility for VWINX. On 3y and 5y basis SPY wins.

One year and YTD VWINX has the advantage again. Impressive track record.

Allright, back on topic ..