ETF and deep ITM calls

Discussion in 'Options' started by sandman55, Apr 17, 2012.

  1. sandman55


    I have done a few options trades, but I'm definitely a beginner and I may be completely off, so bear with me. I am trying to get my head around something and was hoping someone could shed some light.

    Suppose I want to set up the lowest risk strategy options with covered calls. For example, buy SPY and at the same write a very ITM call (e.g. -8% strike or even lower). In the week of expiration I would roll the call by buying the call and writing another deep ITM (same 8% strike below current SPY price) regardless if underlying went up or down, so I could have a debit to roll. If SPY goes down by say 7% I would roll it to a further lower strike or the opposite if it goes up.

    The return would be whatever theta I collect over the period and I would sort of "lock" the underlying, and the end-result would be a fixed income that should be relatively stable (or not?). There could be an early exercise and that would be fine because I would collect the remaining theta right away, buy the stock at current price and write another deep ITM call.

    The objective would be a low risk strategy where my return would be the theta decay of the period only.

    Is there something wrong with this strategy? If not, what kind of return could I expect on 1 year? If I am completely off, an explanation why would be great.
  2. rmorse

    rmorse Sponsor

    The position's profit would be based on the direction of the stock. You're betting the stock does not go down. If it goes below the strike, you'll lose money. You'll receive a similar profit/loss by selling the same strike but using a naked put. Then, after the current put is about to expire, you can buy it back, or let it expire,then sell the next month naked put.


    bTW, in your example, that would likely be a credit roll. The front month would be worth less then the next month. When you roll it would be a credit.
  3. never play losing game!

    or gamble.

    I have a strategy called lottery winning strategy. at the beigging of each month, I buy $1 scratch lottery, then at the end of month, I scratch it and see whether I win something, then at the beginng of next month, I buy $1 scracth lottery again,...

    guesss one day I win the mega-million lottery with $1 ticket, is that right? am I betting low risk?

    just a joke
  4. sandman55


    Thanks Rmorse. Very helpful response and led me to do some reading last night about the selling puts alternative, which does make a lot more sense. My reading last night got me to an atticus post about hedging that with itm index puts. It makes sense, I just need to figure out a way to model all this stuff out.

    The reason I am coming up with this is because I have a rental condo that is paying me less than 8% p.a. and there is the value is not going up by much (if not sinking down) as property prices where I am right now are already through the roof. Something paying me 11-14 with a decent low risk would be a great alternative.

    Thanks agai Rmorse.

    Trader: You are not adding much and if that's supposed to be a joke, it's a boring one.
  5. spindr0


    SPY is 139 and you write a May 128 call for 11-1/4 pts. No problem if SPY stays above above 128. You keep you 1/4 pt... well, some part of it due to 3 commissions.

    But suppose it's Aug of 2011 and the SPY drops 20+ pts in a week. At expiration you keep the 11-1/4 pts but now you're net down 8+ pts on paper. Will you write the call that's 8% ITM, locking in a $8 loss if assigned? I think not. So you'll start writing OTM calls, hoping to break even some day. There goes your clever ITM writing strategy.

    Or maybe a 1/4 pt of TP isn't enough for you. So you go out 3 months and write the Jul 128c for 13 pts. But this time, it's 2008 and the SPY drops 50+ pts in less than 3 months. What are you going to do now? Nothing. You're a bag holder. Eat, pray, beg for a recovery.

    Covered calls have a lousy R/R ratio. You bear most of the risk yet you receive very little of the upside, especially for ITM writes. Like most option strategies, they do quite nicely when the UL cooperates and poorly when it doesn't.
  6. newwurldmn


    I doubt you will get the return (like 30bps/month) to justify the risk and the effort.
  7. sandman55


    Thanks guys - rmorse, sprindr0, newurl. Last night after rmorse's comments I started looking into alternatives considering the equivalent short put. I stumbled upon an interesting post by atticus on selling puts on good low betas and hedging with atm index puts or VIX calls.

    I only started looking into this now, but I would have questions when to choose index calls vs vix calls in such a strategy. In addition, he talks about always writing strike otm but I wonder if it would not make sense to say write 2 otm if, for example, the market is extremely oversold. Would the atm index put would provide some cushion (presumably it would appreciate in value faster then the otm puts since it was atm?)

    Have some studying to do.

    Any input in this respect would be greatly appreciated as well.

    Thanks again