Covered calls
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Selling Covered Calls on ETFs
Thoughts on selling out-of-the-money (by far) covered calls on long-term ETF holdings like SPY?
Re: Selling Covered Calls on ETFs
It's a great idea if they stay out-of-the-money through expiration.
The closest helping hand is at the end of your own arm.
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Re: Selling Covered Calls on ETFs
The option contracts for (far) out of the money calls are only a few dollars. So the profits to the call writer (you) are very little in this strategy. And as per previous poster, the risk is large.
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Re: Selling Covered Calls on ETFs
I wouldn't have much luck doing that.
Last edited by AgentOrange on Thu Jun 01, 2023 8:09 pm, edited 1 time in total.
Re: Selling Covered Calls on ETFs
After dabbling in options sporadically for many years, I finally appreciate that there is no free lunch in options.
Here is how my luck typically works with options (hypothetical scenario)
Lets say I wanted to sell SPY at 440/sh in the next two months, e.g. for rebalancing.
Rather than use a limit sell at 440, I could sell a covered call at 440 to collect premium.
(Current price 5/21 is ~$420/sh)
Using Options Profit Calculator https://www.optionsprofitcalculator.com ... -call.html,
one can get $1.70/contract for :
21st Jul $440 Call,
so $170 of option premium.
Lets say SPY goes up to 450/sh on July 10. The call holder does not need to exercise. The call holder is waiting for a bigger payoff.
If I want to sell SPY at this high price, I would need to buy back the call. If the market volatility is high, and there is
a lot of upward momentum, it will cost more than 450-440=$10/share to buy back the covered call to cancel it. Perhaps $15/share? So I could buy back the call, and sell SPY, which nets $450-$15=$435/share. Not too bad, I only lost $5/share compared to a limit sell at $440.
Now lets say SPY drops on July 11 (the next day) to $410/sh and stays below 440 until expiration. Now the call will expire worthless, and I get to keep my $170 of option premium, but I missed out on the 100x$20/sh =$2000 I would have had with a limit sell at $440.
So I am not lucky enough to use covered calls profitably.
Here is how my luck typically works with options (hypothetical scenario)
Lets say I wanted to sell SPY at 440/sh in the next two months, e.g. for rebalancing.
Rather than use a limit sell at 440, I could sell a covered call at 440 to collect premium.
(Current price 5/21 is ~$420/sh)
Using Options Profit Calculator https://www.optionsprofitcalculator.com ... -call.html,
one can get $1.70/contract for :
21st Jul $440 Call,
so $170 of option premium.
Lets say SPY goes up to 450/sh on July 10. The call holder does not need to exercise. The call holder is waiting for a bigger payoff.
If I want to sell SPY at this high price, I would need to buy back the call. If the market volatility is high, and there is
a lot of upward momentum, it will cost more than 450-440=$10/share to buy back the covered call to cancel it. Perhaps $15/share? So I could buy back the call, and sell SPY, which nets $450-$15=$435/share. Not too bad, I only lost $5/share compared to a limit sell at $440.
Now lets say SPY drops on July 11 (the next day) to $410/sh and stays below 440 until expiration. Now the call will expire worthless, and I get to keep my $170 of option premium, but I missed out on the 100x$20/sh =$2000 I would have had with a limit sell at $440.
So I am not lucky enough to use covered calls profitably.
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Covered calls
Is selling covered calls (that are far out of the money) on index etf investments a bad idea?
I currently own 100 shares of SPY (SPDR S&P 500 etf) and am considering selling out of the money (by far) covered calls to generate extra income. Is this plausible strategy?
Thanks!
- @Isaachemingway
[Topic merged here - mod mkc]
I currently own 100 shares of SPY (SPDR S&P 500 etf) and am considering selling out of the money (by far) covered calls to generate extra income. Is this plausible strategy?
Thanks!
- @Isaachemingway
[Topic merged here - mod mkc]
Re: Covered calls
Yes.isaachemingway wrote: ↑Thu Jun 01, 2023 9:21 am Is selling covered calls (that are far out of the money) on index etf investments a bad idea?
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Re: Covered calls
Yes this works…. Just realize you could lose upside in the market if it takes off and you get called….
Or you can buy them back and roll them out in hopes the market cools back below your strike.
It’s all about patience.
Or you can buy them back and roll them out in hopes the market cools back below your strike.
It’s all about patience.
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Re: Covered calls
What I’ve concluded when writing far out of the money covered calls has been that it’s not worth the effort for me in most cases because the price offered is so low.
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Re: Covered calls
This topic comes up a lot.
It is a mistake to think of writing options as "generating income". You are entering into a functional insurance contract with someone else where you are selling asymmetric risk for a fair market price. It may work for you or it may not..you will probably hold options that expire worthless 90% of the time but 10% of the time lose a lot because your shares got sold well under market. On average the expected benefit will be zero.
It is a mistake to think of writing options as "generating income". You are entering into a functional insurance contract with someone else where you are selling asymmetric risk for a fair market price. It may work for you or it may not..you will probably hold options that expire worthless 90% of the time but 10% of the time lose a lot because your shares got sold well under market. On average the expected benefit will be zero.
Re: Covered calls
This topic comes up every few weeks. The simple answer is there is no free lunch and selling covered calls does not 'generate income', it reduces volatility at the cost of reducing total return.
The slightly less simple answer is there are two ways one might sell calls:
1) Sell them mechanically on a fixed schedule.
2) Sell them strategically.
Option 1 is guaranteed to reduce your total return over the long term. You can look at the long term performance of covered call funds and Buy-Write indices to see this.
Option 2 can beat the market in the same way that timing the market can beat the market, because option 2 IS timing the market.
Beware of anyone who tells you that they've been easily generating bonus income on top of their holdings from covered calls. Virtually all of those people started selling covered calls in the past 12-18 months when popularity of this strategy exploded on social media, so they've been writing calls in a mostly downward trending market. Similarly, beware of Portfolio Visualizer conclusions based on ETFs with inceptions in the past few years.
The slightly less simple answer is there are two ways one might sell calls:
1) Sell them mechanically on a fixed schedule.
2) Sell them strategically.
Option 1 is guaranteed to reduce your total return over the long term. You can look at the long term performance of covered call funds and Buy-Write indices to see this.
Option 2 can beat the market in the same way that timing the market can beat the market, because option 2 IS timing the market.
Beware of anyone who tells you that they've been easily generating bonus income on top of their holdings from covered calls. Virtually all of those people started selling covered calls in the past 12-18 months when popularity of this strategy exploded on social media, so they've been writing calls in a mostly downward trending market. Similarly, beware of Portfolio Visualizer conclusions based on ETFs with inceptions in the past few years.
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Re: Covered calls
It has a high probability of working out if you book 10-15% OTM for 30-60 days, with little to gain (Indexed ETF's have much less volatility compared to single stocks for obvious reasons), but one failed iteration is enough pain to never try it. It's market timing. We may be at a generational low today from this point going forward into the future. You can sell calls against your holdings for 2-3 years (30 days out each time) successfully and then when the market starts going parabolic upward you either lose the holding or have to buy back the call at a loss to close, and that can wipe out all those prior months of small penny pinching gains.
It's funny nobody makes posts about selling calls in an up market, only after a 6-12 month downswing. Just talking out loud, markets being at all time highs is probably the best time to implement covered call strategies. Definitely not when we are 15% off market highs for the past 17 months.
It's funny nobody makes posts about selling calls in an up market, only after a 6-12 month downswing. Just talking out loud, markets being at all time highs is probably the best time to implement covered call strategies. Definitely not when we are 15% off market highs for the past 17 months.
Re: Covered calls
My experience has been it is not worth the effort to write covered calls against index funds. I have a small account where I trade growth stocks for fun and when I have a big profit I will write a covered call if the premium is big enough. If the stock shoots up I just let it get exercised and am happy with my profit. Premiums are too small on my main index funds and I want to hold them for the long run.
Re: Covered calls
isaachemingway,
I merged your new topic on covered calls with your existing identical one. It's best to keep the discussion in one place.
Thank you to the member who reported it and explained what was wrong.
mod mkc
I merged your new topic on covered calls with your existing identical one. It's best to keep the discussion in one place.
Thank you to the member who reported it and explained what was wrong.
mod mkc
Re: Covered calls
Also, be ready for pain - I have a covered call on 50% of my NVDA position and while I am happy with the profit and premium I received it is hard to look at what I gave upNYHawkeye wrote: ↑Thu Jun 01, 2023 11:06 am My experience has been it is not worth the effort to write covered calls against index funds. I have a small account where I trade growth stocks for fun and when I have a big profit I will write a covered call if the premium is big enough. If the stock shoots up I just let it get exercised and am happy with my profit. Premiums are too small on my main index funds and I want to hold them for the long run.
Re: Covered calls
This is the biggest issue with it - hence the saying "picking up pennies in front of a steamroller" - even if you didn't technically lose it certainly feels like a loss.NYHawkeye wrote: ↑Thu Jun 01, 2023 11:11 amAlso, be ready for pain - I have a covered call on 50% of my NVDA position and while I am happy with the profit and premium I received it is hard to look at what I gave upNYHawkeye wrote: ↑Thu Jun 01, 2023 11:06 am My experience has been it is not worth the effort to write covered calls against index funds. I have a small account where I trade growth stocks for fun and when I have a big profit I will write a covered call if the premium is big enough. If the stock shoots up I just let it get exercised and am happy with my profit. Premiums are too small on my main index funds and I want to hold them for the long run.
I did it for awhile in my Vanguard account (which avoids all sorts of tax shenanigans which further ruins profit potential) and it was basically a wash. And don't ask me about the time I sold covered calls against TSLA before it split ...
If you DO want to investigate it further, spend the money to buy Options as a Strategic Investment and actually read it. There's no free lunch, and taxes chew you up, but knowing how and why the options are meant to be used helps understand what you're doing.
Re: Covered calls
I use it on positions I want to sell because I think they will be relatively flat.
Not really the right forum for this kind of strategy though.
I do this with my 5% "fun" I vest money where I speculate.
Other 95% is in total market index etf.
Not really the right forum for this kind of strategy though.
I do this with my 5% "fun" I vest money where I speculate.
Other 95% is in total market index etf.
"Learn every day, but especially from the experiences of others. It’s cheaper!” -- Jack Bogle
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Re: Covered calls
There are mutual funds and ETFs that do this for you. In addition to being possible investments in themselves, they can be taken as some kind of indication of how the strategy generally performs. When executed by professionals. And looking at an average instead of some specific single fund that has gotten attention because it outperformed others.
The Morningstar category is "Derivative Income."
Here is a comparison between the category average for these funds, and the Vanguard Balanced Index Fund (60/40 stocks/bonds). (Since the story for covered calls is that you are investing in stocks, but giving up performance in exchange for lower risk, that seems like a reasonable comparison).
While this looks impressive, on inspection it is noticeable that all of the outperformance occurred before 2009, and that since then, derivative income funds have steadily lagged farther and farther behind Balanced Index:
So, cue the usual debate.
Covered call funds/ETFs experienced a burst of outperformance in 2022--in the sense of losing less money than stocks or bonds, with the result that Jason Zweig has called them "all the rage."
The casual investor can invest in two index funds, a broad stock market fund and a broad bond fund, and tune their overall risk anywhere they like by varying the percentage stock allocation. Alternative strategies should always be compared against this dead-simple approach. It is tempting to suppose that it should be possible to do much better by using sophisticated vehicles requiring financial expertise, and naturally people with this expertise are eager to offer their services. People like to have something special. And, for reasons I don't fully understand, a lot of advanced investors would prefer to reduce risk by doing complicated things--anything, no matter how complicated--purely with stocks (and options and leverage and derivatives and short positions)--than use bonds. I'm skeptical of the benefits.
The Morningstar category is "Derivative Income."
Here is a comparison between the category average for these funds, and the Vanguard Balanced Index Fund (60/40 stocks/bonds). (Since the story for covered calls is that you are investing in stocks, but giving up performance in exchange for lower risk, that seems like a reasonable comparison).
While this looks impressive, on inspection it is noticeable that all of the outperformance occurred before 2009, and that since then, derivative income funds have steadily lagged farther and farther behind Balanced Index:
So, cue the usual debate.
Covered call funds/ETFs experienced a burst of outperformance in 2022--in the sense of losing less money than stocks or bonds, with the result that Jason Zweig has called them "all the rage."
The casual investor can invest in two index funds, a broad stock market fund and a broad bond fund, and tune their overall risk anywhere they like by varying the percentage stock allocation. Alternative strategies should always be compared against this dead-simple approach. It is tempting to suppose that it should be possible to do much better by using sophisticated vehicles requiring financial expertise, and naturally people with this expertise are eager to offer their services. People like to have something special. And, for reasons I don't fully understand, a lot of advanced investors would prefer to reduce risk by doing complicated things--anything, no matter how complicated--purely with stocks (and options and leverage and derivatives and short positions)--than use bonds. I'm skeptical of the benefits.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
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Re: Covered calls
Why?Chuck wrote: ↑Thu Jun 01, 2023 9:59 amYes.isaachemingway wrote: ↑Thu Jun 01, 2023 9:21 am Is selling covered calls (that are far out of the money) on index etf investments a bad idea?
Thanks!
- @isaachemingway
Re: Covered calls
Were the other replies above explaining why too long for you?isaachemingway wrote: ↑Fri Jun 02, 2023 9:02 amWhy?Chuck wrote: ↑Thu Jun 01, 2023 9:59 amYes.isaachemingway wrote: ↑Thu Jun 01, 2023 9:21 am Is selling covered calls (that are far out of the money) on index etf investments a bad idea?
Thanks!
- @isaachemingway
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Re: Covered calls
Great points! However, don't covered call mutual funds (with long track records) underperform the market because they sell near-the-money options to generate significant portfolio income? The portfolio income that I would be aiming to generate would be about 0.20% per year (by selling 7-15% OTM call options), not the 9-10% yields that covered call funds generate.20cm wrote: ↑Thu Jun 01, 2023 10:39 am This topic comes up every few weeks. The simple answer is there is no free lunch and selling covered calls does not 'generate income', it reduces volatility at the cost of reducing total return.
The slightly less simple answer is there are two ways one might sell calls:
1) Sell them mechanically on a fixed schedule.
2) Sell them strategically.
Option 1 is guaranteed to reduce your total return over the long term. You can look at the long term performance of covered call funds and Buy-Write indices to see this.
Option 2 can beat the market in the same way that timing the market can beat the market, because option 2 IS timing the market.
Beware of anyone who tells you that they've been easily generating bonus income on top of their holdings from covered calls. Virtually all of those people started selling covered calls in the past 12-18 months when popularity of this strategy exploded on social media, so they've been writing calls in a mostly downward trending market. Similarly, beware of Portfolio Visualizer conclusions based on ETFs with inceptions in the past few years.
Does that make a difference in your point about being "guaranteed to reduce your total return over the long term"?
Thanks!
- @isaachemingway
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Re: Covered calls
No worries! I had forgotten that I had already posted about it!
Re: Covered calls
It makes no difference. There can't exist a mechanically-executed strategy where you get a higher long-term return in exchange for a lower risk.isaachemingway wrote: ↑Fri Jun 02, 2023 9:24 am Great points! However, don't covered call mutual funds (with long track records) underperform the market because they sell near-the-money options to generate significant portfolio income? The portfolio income that I would be aiming to generate would be about 0.20% per year (by selling 7-15% OTM call options), not the 9-10% yields that covered call funds generate.
Does that make a difference in your point about being "guaranteed to reduce your total return over the long term"?
There isn't some OTM-ness threshold where a mechanical call writing strategy transitions from dragging down total long-term return to increasing it. Going further OTM just means that it can seem to be working for a longer period of time before you hit the gotcha.
Covered calls give up most of the right tail while keeping most of the left tail of the returns distribution. Moving further OTM just means you keep a little bit more of the right tail while also keeping much more of the left tail.
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Re: Covered calls
My favorite quote of the month!
Thanks!
- @isaachemingway
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Re: Covered calls
Great point, I agree. Here's my conclusion:20cm wrote: ↑Fri Jun 02, 2023 9:44 amGoing further OTM just means that it can seem to be working for a longer period of time before you hit the gotcha.isaachemingway wrote: ↑Fri Jun 02, 2023 9:24 am Great points! However, don't covered call mutual funds (with long track records) underperform the market because they sell near-the-money options to generate significant portfolio income? The portfolio income that I would be aiming to generate would be about 0.20% per year (by selling 7-15% OTM call options), not the 9-10% yields that covered call funds generate.
Does that make a difference in your point about being "guaranteed to reduce your total return over the long term"?
Let's say that you sell the farthest out-of-the-money weekly covered call options that you can for 0.02 a pop (a realistic premium for 5-10% OTM weekly SPY calls) on a 100-share position of SPY for two years and make $200 for TWO YEARS of effort ($2 in premium per mkt trading week). Then, one week, you execute your standard call writing and sell a 7% OTM SPY call option with a strike of $500. That week, SPY pops up to $503 (only a .6% difference from your strike), and you get assigned and lose $3/share ($300) of upside. All of your covered call gains from the past TWO YEARS ($200) are wiped out by lost upside and, on top of that, you lose an additional $100 of upside (a whole year's worth of covered call writing) and (because you had to sell your shares for $500) have to pay capital gains tax on your SPY position (potentially 1000s of $'s). All of that effort turned out to be pinching pennies in front of a steamroller, feeling smart until the steamroller (although rare) hit.
Even if writing "low risk" OTM covered calls for years works every time, it only takes one small fluke to erase years of meager covered call premiums, get hit by the tax man, and miss out on market upside.
Thanks for all of your helpful input!
- @isaachemingway
Re: Covered calls
There's a good reason selling covered calls are often referred to as "picking up nickels in front of a steamroller".
Re: Covered calls
I guess the most important question to ask yourself is "if the stock exploded upwards past my strike price, would I be okay selling these shares away at that price?" If yes, then potentially consider it. But if you don't want to lose the underlying shares in question, or if you feel sad when pocketing smaller gains while missing out on a huge jump, best to avoid covered calls.
Also smart to consider tax implications. Premiums from selling options are always short term capital gains, and thus taxed at top rate. Also consider the tax implications of your underlying shares potentially being called away at an inopportune time. These particular tax issues can be avoided though if you stick to only option selling inside a Roth IRA or other tax advantaged account.
Also smart to consider tax implications. Premiums from selling options are always short term capital gains, and thus taxed at top rate. Also consider the tax implications of your underlying shares potentially being called away at an inopportune time. These particular tax issues can be avoided though if you stick to only option selling inside a Roth IRA or other tax advantaged account.
Re: Covered calls
Heh, heh, heh! That's what I thought, until my AMZN got called away more than a decade ago. How much did that little profit cost me? Yikes! I'm too scared to calculate the amount.NYHawkeye wrote: ↑Thu Jun 01, 2023 11:06 am My experience has been it is not worth the effort to write covered calls against index funds. I have a small account where I trade growth stocks for fun and when I have a big profit I will write a covered call if the premium is big enough. If the stock shoots up I just let it get exercised and am happy with my profit. Premiums are too small on my main index funds and I want to hold them for the long run.
And to those who say, "Well you can just buy back the stock on a 'pull back'." That only works if there is a pull back. Or you have to have the courage to buy it back at a much higher price.
The difficulty with jazz is there are too many notes. (Borrowed from Emperor's critique in Amadeus)
Re: Covered calls
Someone mentioned it but if I want to unload 100 shares I often sell a covered call against the current price a few days or weeks into the future.
Of course, you can STILL get blowed up if the price drops. So it has to be a “I kinda wanna sell but don’t care not selling”.
Or you can sell a call against somewhat lower than the price (but it’s not dollar for dollar after a point).
It’s all shifting around risk/rewards.
Of course, you can STILL get blowed up if the price drops. So it has to be a “I kinda wanna sell but don’t care not selling”.
Or you can sell a call against somewhat lower than the price (but it’s not dollar for dollar after a point).
It’s all shifting around risk/rewards.