The most conservative options income strategy is probably calendar spreads, sell an ATM call or put about 40 days out and buy the same strike price the following month. This strategy takes advantage of theta (time decay), and your risk is limited to basically what you pay for the calendar. You can also adjust it as prices move.
re:"The most conservative options income strategy is probably calendar spreads, sell an ATM call or put about 40 days out and buy the same strike price the following month. This strategy takes advantage of theta (time decay), and your risk is limited to basically what you pay for the calendar. You can also adjust it as prices move." this assumes that one thinks non directional trades are more conservative/less risky than directional trades. if you put on a calendar trade(one type of time spread/nondirectional) or straddles(one type of directlonal trade) on at the wrong time, for example, when IV is high, you pretty much "guarantee" either trade will lose $$$.
As promised, I am attaching a spreadsheet with the work I have been doing exploring SPY with my strategies, for anyone who cares. For the haters who don't like long posts, or short attention span, you can skip this post immediately. Otherwise, read on. The spreadsheet is in openoffice 3.3 format, which is free for all to use. It includes macros , so you need to enable macros in tools/options/security/macro security and set level to "medium". I got the macros are from http://www.optiontradingtips.com/pricing/free-spreadsheet.html . The SPY and VIX price data is from yahoo finance. There are two sheets . The one with the most interesting data is the one titled "sell put, sell assigned shares". This assumes a weekly put is sold on monday morning at the open, which expires on friday. Ie. 5 day duration. No early assignment is assignment, only saturday. It is assumed that assigned shares are only available on saturday, ie. they cannot be sold until the following week. Early assignments would have a positive net effect on performance, since it would add more days for them to be sold, and improve the odds that they will be sold. The only negative would be higher commissions for partial lots. This spreadsheet does not even try to account for commissions yet. I expect they will be high. It does not try to account for annual taxes yet, either. This can be brutal, especially when one is holding depressed shares such as can happen in 2009 and even 2010 in some of the scenarios. The main input variables are : 1) target put strike price relative to stock price open. In the version I am uploading, I set it to 98% . This is in cell F2. It's very interesting to see the premium changes when this is changed. 2) put buyback price. This is in cell N2 . It is a percentage. I set it to 0% right now because it is generally not profitable to buyback the put. The assignments are too unpredictable, for large stock moves. Buying back the put just reduces returns and provides no protection, unless you always buy it back at a very high cost, such as 95% of its original value. But then, there is little to no profit. The way I figure out whether the put ever goes to the target price is by computing the price of the put in column M5, at the weekly high for the stock price, and assuming the stock moves up to that high right after selling the put on monday morning. Ie. there is still 5 days duration left. The same volatility is used. I only input the VIX value for monday morning open. This is somewhat of a worst case low for the put value. Most likely, the put would go much lower if the stock high happens later in the week. But volatility could also make it cost more. 3) percentage of cash balance to write the puts against. This is in cell AE2 . I left it at 100%. This seems to provide the best returns, with the most risk of course. 4) profit target on shares after assigned. This is in cell AF2. I left it at 0%. Ie, the strategy places limit orders at the assignment price. This actually works out OK, but not great. Anything greater than 0.5% highly increases the chance that one is left holding the shares for an extended period, possibly even until the end of the period. Since my goal is not to hold shares if possible, I feel this is the right target. It is interesting to set this negatively too and experiment, ie. take a loss willingly on the shares when one is assigned. For example, setting this to -1% only minimally reduces the annual return, from 7.08% to 6.80%. This is because there are far more weeks that I can sell puts that never get assigned, as a result. The loss on the stock is almost fully compensated by the additional put premiums. With a 0% profit target, starting with $300k in cash, one is stuck holding SPY shares from 9/22/2008 through 6/21/2010. Quite a long time. And as a result, there is a low account balance of $181k in march 2009. With -1% profit target, the shares are always sold quickly. The longest holding period is 6 weeks, from the week of 2/09/2009 through 3/16/2009. And the low account value is $249k, much higher. Taking the 1% loss voluntarily when the bet goes wrong reduces volatility quite a bit without drastically reducing the return. With a +0.5% profit target, the annual return jumps to 8.92% ! And the holding periods are very close to that for 0% target. 5) initial cash balance. This is in cell AC4. I set this to $300k. This is the amount I would be comfortable investing. I would keep $100k as an emergency fund. This covers about 9 months of living expenses. The main outputs are : 1) annualized return. This is in cell AG2. With the variables I have set above, it's a pretty nice 7.08%. But even very small tweaks to the input variables can have large effects on the return. So, I am not confident this can really work in practice at all. 2) low account value. This is in cell AG11. Seems to almost always occur in march 2009 if one is holding shares at that time. With the parameters currently set, the low value is $181k in march 2009. Which is about a 40% unrealized loss from the previous year. Quite high. 3) high account value. This is in cell AG11. This tends to be the final account value for most cases, which is a good sign With the data I selected, it ends at $384K cash position. Holding SPY over the same period would have a return close to 0 - initial price was $131 and we are not quite there yet, but the dividends might make up for it. There is a second sheet that that says "sell covered puts, sell covered calls". It uses the same strategy as the other, except every monday morning that there is an SPY position, it sells a 5 day call at the next highest strike price above cost. It assumes the shares are never called early. They are only called or not called based on the week's closing price. This ends up comparing very unfavorably with placing a limit order on monday morning. One reason is that one can get sell at the exact price (dollars and cents), whereas with the call, it is the next highest dollar amount. But the main reason is that in a bear market, such as this 2008 data, the first call expires worthless because the stock has moved down too much at the end of the week. As it continues to move down, the next week's call premium is much lower, and quickly becomes zero. Whereas, the limit order may actually have executed during the first week, based on weekly lows/high, avoiding further losses. Using all the other inputs identical with the limit order strategy, one ends up with a negative return over the whole period, holding 2300 shares held since 9/22/2008 with an average cost of $136.05 ... And a total account balance of $298k after 3.5 years. This one sheet doesn't include dividends yet, and it would be a positive return with them included, but still a very small one. So, I'm inclined to forget about selling calls against assigned shares, and just try to sell the assigned shares ASAP instead. This is much less risky and improves the return. The only exception would be if one were to sell a long dated call instead, such as for a 3 months or even one year period at a time. I'm still not sure this is worth it due to the remaining downside risk. The return for this case would be better, but one could still never get called, and be stuck holding overpriced shares for years. I intend to merge the two spreadsheets together to play with the covered call selling strategy some more, but based on what I have seen, I doubt it will be very beneficial. All in all, the first strategy - sell SPY covered put, and sell assigned shares ASAP at limit - doesn't seem too hard to execute. In theory, I only have to place one trade a week, every monday morning at the open. Either I write a covered put, if there is cash in the account, or I place a limit order to sell if there are shares. I might have to place more limit orders during the week to sell the shares in cases of early/partial assignments. I just don't know if it's worth it, given the remaining volatility in my data. I certainly wouldn't try this on an individual stock. I believe the strategy could be improved with additional work. For example, sell the weekly options thursday morning instead, when they are issued. They would be good for 9 days instead of 5. This increases the premium - and the risk of assignment. But it complicates things a lot. First, I have to input all the daily data to backtest it, and I have only input weekly data so far. Yes, I know, it's on yahoo. Second, I would have to buyback the put before expiration, at some limit I would have to decide on, in order to be able to do this again every week with a 9 day put. This costs additional commissions. It's a a lot harder to backtest and put in practice. Thank you guys for reading that far.
Hmm, I wasn't allowed to attach the ODS spreadsheet. Here is a ZIP with the ODS in it. I hope it works.
IVTrader, I will read about those. Never invested in an MLP before. I didn't open most of those accounts specifically with the purpose of options trading in mind. I have had to open some of them for other reasons, for example ESPP. For fidelity I have used the brokerage account to collect the cash rewards for my credit card, and to invest in some bonds. This is the one I used for my recent SPY LEAPS call purchase as well. I have been reading a lot of material from the OIC and taken a few of the classes .
I might do that with a dividend index, not individual shares. I will have to check what the yields are. Looks like DVY is at 3.5%. Ultimately, what matters is the total return, though. The yield doesn't matter much if the share price goes down over time. The downside risk to share price is no less of a concern with it than with SPY, though.
cyoungmark, Thanks. Did you mean buying the stock and selling covered calls against it ? I just wouldn't want to hold AT&T shares. I don't like individual stock risk. There is a merger with T-Mobile going on. Which I hope doesn't go through, as a T-mobile customer. There are too many things to worry about when holding individual stocks and this is one risk I don't feel I have to take to achieve the returns I'm looking for.
There are various ways to achieve that with more moderate risk. 1) Utilities 2) Preferred stocks 3) OTM naked puts (or CC's if you own the UL) on quality stocks with you're willing to own that pay decent dividends 4) More complicated ed option strategies
You may find this thread to have some interesting ideas, simply because it's kind of the same idea (lower risk, consistent returns). http://www.elitetrader.com/vb/showthread.php?threadid=206482&perpage=6&pagenumber=3 I particularly like the incorporation of the volatility index (VIX, or VXX) as a hedge against catastrophic events.