I will describe below what I do and I donot know what could possibly go wrong in my strategy. I am not suggesting nothing will go wrong but I donot know and that is why I am posing this question here. I fear there will be something and I have not been able to figure that out. My strategy is very simple. I have selected ETFs which have weekly options. Mostly I concentrate on SPY, IWM, QQQQ,EEM, GDX ,USO,. I write weekly covered calls on them. I have an account with IB and I make sure I only use 50% of my equity with IB. I donot want my a/c to get wiped out and I also donot want margin calls from IB. I have been doing covered calls on these for over a year and when weekleys started I moved my options on a weekley basis. I get regular income and keeps me busy as I have to renew positions every week. What could possibly go wrong ? Thanks , all comments much appreciated.
Thanks for the comment. Can this happen even though I have 50% with IB doing nothing. If so how do I hedge?
You can hedge small moves but a big crash you can't its better to sell puts out right because of the skew basically the market knows big down moves are possible so they bid up the price of otm puts. In principle selling otm puts should be a positive edge strategy. But you need to accept big draw-downs when the "impossible" happens remember the flash crash. But you have one advantage with puts you can't lose more than the strike price. So if you have that cash in your account, you should be fine. Basically you need to decide on what the edge is then apply something like the Kelly criterion on how much to bet on each short expiry.
I have heard that IB will liquidate your positions (from least liquid first order) if their risk management computer feels that your trade is risky. So do not go by the standard Reg-T requirements. Etrade or TD etc.. follow the standard Reg-T requirements IB has a different system.
I have said this many times and I will say it again, don't mistake bull market for brains. The market has pretty much been a one way street so no wonder covered calls did well. As the other poster pointed out, a covered call is exactly the same as a short put. In fact, you should switch to short puts (cash secured, of course) to save on commissions and slippage. Essentially, you have a capped upside profit and an unbound downside loss (well, the ETF cannot fall below zero so, theoretically, it is bound by zero, but the risk is substantial). If the market takes a dive, you are standing to lose a lot on the long ETF positions as the calls wouldn't be able to offset much of that loss. If you have a hard time imagining what could go wrong, just pull up a chart of SPY or any other index ETF and look at the move end of June this year.
I don't know IB's margin limit parameters but I really doubt that they're interpreting which trades are risky. You either have the margin or you don't.
If you have a hard time imagining what could go wrong, just pull up a chart of SPY or any other index ETF and look at the move end of June this year. Thanks MTE I had several positions end of June and nothing had happened. SPY and others gradually went up and I have continued to do the same as before. IB did not give me any margin calls nor any of my positions were liquidated. As I have pointed in my post i always have 50% free cash. This has probably helped me. Thanks
It depends on how you define "wrong". Getting wiped out is highly unlikely. On 50% margin, it would take a 50 % drop to wipe you out (premiums received would make it slightly more). Since that's unlikely to happen in any given day, your broker would liquidate your account at their margin maintenance level which is approx 30% (brokers can require more). OK, so no wipe out but possibly quite the haircut. Take a look at your indexes during Sep and Oct of 2008 and extrapolate how much that would have hurt with your current strategy.