Making 4% a year selling deep OTM covered calls?

Discussion in 'Strategy Development' started by Humble Investor, May 2, 2018.

  1. I own bunch of non-dividend paying small cap stocks, so from time to time I reluctantly have to sell some of my stocks to cover my expenses which comes to around 4% of my portfolio per year. Is it possible to make 4% a year selling deep OTM covered calls without limiting too much of upside potential? Is it better to sell monthly or longer term options? I plan to sell 90 day deep OTM options to fully take advantage of time decay.
    Any thought/suggestions? Thanks.
  2. Stocks like other assets are investments. It is a much wiser choice if you treat them as such. If you are in the game to maximize returns then you should treat each of those stocks as an individual investment. If you need to sell a fraction to free up cash flow then just do so. Otherwise if you believe in the upside potential then hold them in the portfolio.

    You try to want to be smart with options but you may fail to realize that those covered calls will greatly clout your judgement and you will also incur additional commission, different tax implication (depending on your jurisdiction), margin considerations. You by definition limit upside with covered calls. Far out of the money calls won't get you sufficient premium. You have to realize that options are zero sum assets while stocks are not. Well you heard the qualitative argument against covered calls but even mathematically covered calls provide zero benefit, in fact you can derive that yourself by going through multiple scenario analyses and by incorporating all arising cash flows.

    In general, almost always in investments and finance it is the best advice to keep things extremely simple.

    WoodMan483 and Humble Investor like this.
  3. believezz


    Theta decay is highest for short term options.

    I believe one should still look for an edge, even when selling covered calls. Such as finding mispriced options or timing. Otherwise it'll just be an -EV asymmetric payout trade with the illusion of being profitable, until a home run is missed.

    Choosing the correct strike / maturity is tough when you don't plan to adjust your greeks dynamically, which requires continuous monitoring and trading. Instead of thinking "will the stock reach $x in 3 months?", it should be "How my greeks today will perform T+1?". Periods after T+1 has more uncertainty and can be worried about and adjusted for later.

    If a 90 days option is bought/sold and planned to hold until maturity, you wouldn't know your view nor your delta in 30 days, but you'll still keep it for another 60. That's too much in the dark.

    An analogy in sports betting is betting a team to win the champion during semi-finals. Why not bet it to make the finals first, and if the view remains unchanged later, bet the proceeds onto it winning finals? The payout should remains the same assuming no mispricing and "news". This "news" should be random variance (e.g. players getting injured) and avoided.

    So in short IMO options trading is only suitable when there is an edge, and will be monitored and adjusted for continuously (perhaps daily). Or stick to shorter term ones.
  4. JackRab


    Depending on the implied vols if it's interesting really, to make the needed premium.

    Currently ATM SPX impl vol about 1 year out is 15.5... that means that if you want to sell an OTM call at 4% premium... that would be the 2740 call... which is only less than 4% OTM, so not exactly far away.

    You could look at monthly options... which are about 13.5 IV currently. To get to 4% yearly, you would need a 0.33% premium... which would also be the call that's roughly 4% OTM... again, not far away but if you would roll it every time it's not so much of a problem.

    But you do need to realize that you give up any gains above this level.

    I think weekly would be too much of a rollercoaster for you.... the call you would want to sell is too close to the ATM on my opinion.

    Better, depending on what's in your portfolio... you could look at individual stocks and their options, since they generally have a higher IV and therefore, to get to the same premium, you could get away with selling further OTM. I assume, since you have small caps... their IVs would be double that of the SPX.

    You would be looking at selling something that's about 15-20% OTM I guess... that gives you some room to play.

    And, if you want to be more active... I guess you could rollover your short calls when the market drops a bit... but you would be more actively involved in maintaining delta etc. Don't know if you want that.
    Last edited: May 2, 2018
    Humble Investor likes this.
  5. drcha


    Most small cap stocks have poor bid-ask spreads. Look at some option chains. And they will get called away at some point.
  6. Covered calls are a good strategy, but like any strategy involving options you have to tweak it a bit sometimes. It helps to put on a position, and then weigh 3, 4, or 5 different outcomes over different timeframes. For example, what are you going to do when the long stock tanks? Average down?, use stock repair? As long as you adequately prepare, it should work. Being able to make a decision and act without thought because you already decided ahead of time is a valuable skill, and one that will save you stress.
  7. What prompts you to say they are a good investment? What rational do you have? Is there a mathematical way to quantify your claim? Serious question because no matter how I look at it they are a poor choice.

  8. tommcginnis


    Cuz it's demonstrably true?
    "Money"? (One would figure that would be appropo.....)
    Reward/Risk for any major US Index over 20+ years? Gee! Golly!
    I recommend Google. Solves a LOT of Practiced Ignorance problems. They're working to get it into The White House as we speak.....:wtf:

  9. Please don't carry your anger of your disagreement about TA between us into every post I make. I specifically and in respectful and polite terms inquired about another person's claims. If you take issue with that why not just move on.? By the way I inquired because covered call writing demonstrably does not pose any benefit. Hardly any of the buy side firms do it for clear reasons. I was simply bewildered why someone makes an unsubstantiated assumption to the contrary. You have not commented on any of the valid points I made that speak against covered call writing. None of what you wrote pertains to any specific issue regarding covered calls. Perhaps you actually replied by mistake on the wrong topic?

    Lastly, just because you don't like a message why do you need to shoot the messenger? It's a little condescending to recommend looking things up on the net to someone who has traded options in both rates and equity markets for over 15 years at several sell side firms and hedge funds both in market making and prop capacity. Do you have comparable experience and skill sets that justify your attitude? Why having to be so arrogant?

  10. Thank you all for your inputs. I don't plan to do this often. One of my stocks is gone from $8.50 to $40 in less than 6 months and I really don't want to sell it yet because insiders keeps buying. So I thought I should sell some $50 OTM calls. To be honest I have never sold options before, just simple long call/put.
    I just checked the same position which is currently trading at $40/share. I can sell $50 strike June calls with IV of 55% for at least $0.50 or 1.25% in 43 days. Not bad given that I don't have to sell my shares and I can cover my expenses!
    #10     May 3, 2018