Repair strategy for a covered call that's way in the money.

Click onto the very good BCI blog for a video/review of a $75 (strike price) covered call with the underlying stock over $100 at the expiration date!  Blue Collar Investor - FIVE's repair (roll) strategy

ETFs vs individual stocks #2.

I looked at a blog for the first time today & liked the post on covered calls versus DOW 30 stocks.  (Blue Collar Investor - covered calls, DJIA).  I even added BCI to my blog's reading list.  In my IRA, I sell the monthly cash secured puts against broad based ETFs to help me buy, & then, after assignment to buy the ETF, I sell the monthly covered calls to help me to sell it.  I've considered using individual stocks, & even reviewed the BCI post's idea at today's market close.  I did the arithmetic with DIA ($248.70), the ETF that invests in the DJIA's 30 stocks, & with WMT ($102.42) - Walmart - one of the DJIA's stocks.  To maintain apples to apples, both equities have a current dividend yield of about 2.1%; & I selected the 11/16/18 puts & calls that were about 2.5% out of the money.  I calculated what I call the premium yield - for puts, I divide the premium's BID by the strike price (the amount of cash reserved); for calls, I divide the premium's BID by the equity's market value.  Using the time until expiration - 17 days - I annualized the premium yield.  For selling puts, DIA's annualized premium yield was 25%, WMT's was 39%.  For selling calls, DIA's was 18%, WMT's was 36%.  I'm sure I'll re-visit the individual stock idea for my IRA, but how do you feel about covered calls (cash secured puts) versus ETFs?

Covered call premiums to complement the dividend.

Did you ever hear an investor saying, "although my stock is getting beat up, at least I'm being paid its dividend as I hold it, waiting for it to recover?" I'm applying that rationale to my recent IRA investment in SPY, the ETF that holds the stocks of the S&P 500.  Via a put assignment on 10/19/18, I paid $288.05 a share (strike price minus the sold put's premium).  SPY closed today at $263.69.  When I sold the put, I knew that SPY was high, but I try not to guess its direction.  I just want to own it, because I need equity allocation.  And I'm not going to sell it at this low price.  At least I'm being paid its dividend as I hold it, waiting for it to recover.  Its dividend's current yield is around 1.9%, which amounts to about $5 a year, or 42 cents a month (it pays quarterly).  To be honest, the dividend is hardly great consolation versus my nearly $25 loss.  But, applying my consistent option selling strategy, I've also sold covered calls against my SPY since 10/19/18.  On 10/22/18, with SPY already down to $275.26, I sold the 11/16/18, $280.50 call & received a $2.33 premium.  As the October debacle continued, with SPY trading at $264.97 today, I applied a covered call roll strategy to my SPY position.  I like calling it a repair strategy, & more appropriately so.  I was able to buy back the 11/16/18, $280.50 call (which I sold on 10/22/18 for $2.33) for a $0.51 premium & I immediately sold the 11/16/18, $273.50 call for a $1.93 premium.  I earned a $1.42 premium credit with my SPY repair strategy.  In covered call premiums, I've garnered $3.75, which is 1.3% of my $288.05 net cost for SPY.  If I don't earn any more covered call premiums on my SPY through 11/16/18, my annualized premium yield is over 15% (1.3% X 12 months).  That's a nice complement to the SPY dividend's 1.9% current yield!  (Suppose SPY exceeds $273.50 in advance of the 11/16/18 close; any ideas?)                          

Flexibility, creativity with covered calls: roll strategy as a hedge

In my IRA's option selling strategy, I use TLT, an ETF that holds long term US Treasurys, to provide a 35% fixed income allocation.  On 9/25/18, I was short the TLT, October 19, 2018, $120 (covered) call.  TLT was at $116.54.  I could have maintained the short $120 call, & continued hoping that TLT would approach $120 by 10/19/18.  The 10 year Treasury was yielding 3.10%, but I can't predict its future.  I chose a roll strategy, which I prefer calling a repair strategy.  I bought back the October 19, 2018, $120 call, for a 15 cent premium.  I then immediately sold the October 19, 2018, $117 call, for an 87 cent premium.  I netted a 72 cent credit for my IRA.  Considering the 24 days that remained until expiration, the $0.72 divided by $116.54 provided what I call a 9.4% annualized premium yield.  On option expiration Friday, 10/19/18, the 10 year Treasury yielded 3.20%, TLT closed at $113.71 & my $117 call expired worthless; no assignment to sell my TLT.  Had I simply maintained my short $120 call, I would have lost 2.21% ($116.54 - $113.71 + a 26 cent dividend received on 10/5/18 = $2.57 loss/$116.54).  With the repair strategy, I created a hedge to combat the falling TLT (& rising Treasury yield), & lost only 1.59% ($116.54 - $113.71 + the same 26 cent div + the 72 cent premium credit = only $1.85 loss/$116.54)!                 

Selling puts against ETFs versus stocks?

I read a good post on a blog that I enjoy - tastytrade, stocks versus ETFs - about trading options using ETFs versus single stocks.  Author Sage Anderson emphasized the different volatility & of course, the different risk.  In my IRA, I sell puts against SPY, the ETF that holds the stocks of the S&P 500 index.  But I've often considered selling puts against individual stocks, to get more of what I call premium yield.  I'm bullish on oil, so XOM (Exxon Mobil, in the S&P 500's top 10) is a stock to consider for selling puts against.  Around yesterday's trading close, I reviewed the November 16, 2018, SPY & XOM puts.  SPY was at $280.42 & XOM was at $81.32.  Unlike Anderson, I don't look at the volatility index.  But I do look at arithmetic because for me, it really quantifies the risk.  I chose the SPY $276 put & the XOM $80 put because they were both about 1.6% out of the money.  Since I'm a put seller, I consider the premium's BID price - $3.01 for SPY & $1.60 for XOM - when I calculate premium yield.  Selling cash secured puts, I must reserve $276 (per contract share) for SPY & $80 for XOM in my IRA's core position.  For selling the SPY put, $3.01 divided by $276 = 1.09% over 30 days, or 13.27% annualized.  For selling the XOM put, $1.60/$80 = 2.00%; 24.33% annualized.  The 24.33% premium yield is very attractive, but I'm afraid of XOM's put selling risk - dropping to $40, or to $0!  SPY's 13.27% premium yield is quite attractive, but I'm not afraid that SPY will tank to $138, or to $0!                   

addendum to today's earlier post

In today's earlier post on price improvement, retrieval of the Barron's story is inconsistent.  At times, the full story popped up.  At other times, only the story's introduction popped up, with an invitation to subscribe to Barron's.  I've tried Google Chrome & Microsoft Edge with the same experience.  This Fidelity link is very helpful, albeit it's not a 3rd party reference:  Fidelity Investments, trade execution

To sell (& buy) options, I prefer market orders, & rely on "price improvement."

Many traders say, "too much risk of getting jabbed when using market orders to trade options...especially with big spreads...always use limit orders." But I use market orders most of the time.  With limit orders, I fear missing the trade to save a few pennies.  I use Fidelity Investments & Fidelity's price improvement has been a gigantic benefit.  (Full disclosure:  I retired from Fidelity Investments in 2017.)  Here's what I mean:  On 7/20/18, I sold 12 contracts of the TLT (US Treasury ETF), August 17, 2018, $119 (covered) call, at the market, & received a $2.21 premium.  A $2.14 BID & (around) $2.25 ASK was displayed before my trade.  As the seller, I was entitled to receive the $2.14 BID.  The buyer was obliged to pay the $2.25 ASK.  I could have placed a $2.21 limit order, but I didn't want to miss the trade.  The market maker wanted that 11 cent spread, & if I requested $2.21, I was asking them to nick their take to 4 pennies.  I was extremely trusting of Fidelity's trade execution & price improvement reputation.  With my market order, I was really asking Fidelity to get the market maker to better my price.  If I received $2.14 (or less ["jabbed?"], which could have happened), fine; I wanted the trade executed.  I know that Fidelity invests a ton of money into trade execution technology & market makers keenly want Fidelity's business.  On my trade, the market maker agreed to accepting a lower spread & I received $2.21.  That's price improvement of 7 cents.  12 contracts control 1,200 shares; at $0.07, that's $84 in price improvement.  On my account's balance page, Fidelity reports my rolling 12 month price improvement:  $1,062 in my rollover IRA among my 53 trades.  I've linked a Barron's story.  It's 3 years old, but serves as a good primer.  Barron's, price improvement                 

Should I have sold Fidelity Contrafund to "sell puts, then calls?"

On 8/17/17, upon retiring from Fidelity Investments, I sold $376K of my Fidelity Contrafund (which I had built over 10+ years) & directly rolled over that amount from my 401K into my IRA.  With this $376K, I sold puts against 4 ETFs, & if I was forced to buy an ETF, I sold calls against it.  Every month, consistently.  My target allocation was 40% SPY (S&P 500), 15% EFA (developed-int'l), 10% EEM (emerging-int'l) & 35% TLT (US Treasurys).  I added $14K to this $376K over the next year, & on 8/20/18, my option selling strategy was valued at $402K.  The $12K increase amounted to a 3.03% return.  On 8/20/18, my allocation was skewed to 28% SPY, 18% EFA, 18% EEM & 36% TLT.  Had I kept my $376K in Fidelity Contrafund on 8/17/17, on 8/20/18 it would have been worth $467K, returning 24.2%.  Did I make a mistake?  I'd love to hear my readers' comments. 

Why the early assignment of a DIA call against me?

Despite my vigilance against early call assignments (see my previous post), I received one on 7/19/18, the day before option expiration Friday.  On 7/2/18, I had sold the DIA July $245 call against my DIA shares, when DIA traded for $241.03.  (DIA is the ETF that holds the 30 stocks of the Dow Jones Industrial Average.)  On 7/19/18, DIA closed at $250.79, over $5 in the money.  I had planned to visit the position on 7/20/18, option expiration Friday, to consider a one month repair (roll out) to an August call, to avoid the July assignment (e.g., buying back the July $245 call & selling the August $253 call).  When I visited the position on July 20, I was surprised to find that my DIA call had been pre-maturely assigned the night before, forcing me to sell my DIA.  I had presumed that DIA's ex-dividend date on its 32 cent monthly div was August 1.  However, DIA goes ex-div on the 3rd Friday of the month (July 20), & I was assigned the day before, ensuring that the buyer receives the div along with the cheap ETF.           

Mea culpa, mea culpa, mea maxima culpa.

Pardon the appearance of my website.  Normally I wouldn't send out a first post while the blog is under construction, but I'm such an IT Luddite that waiting to post until the site appearance is respectable might take forever & I'd never get to satisfy my objective of helping you with option selling.  Plus, since I do have a pretty good sense for conveying the nuances of this arcane strategy, I hope you find it's worth getting going now rather than waiting until my site is pretty.

And - please pardon me again, because this sounds quite self-serving - I do want to promote my 144 page, recently published primer Selling Options...Simply Called and Simply Put.  However, I don't even know how to link the "Buy Now" button.  I am confident though, that even if you have zero understanding of option trading, as long as you have a keen desire to learn the strategy, my crystal clear book will be most helpful.

In a future post, I'll tell you a bit about myself, including my experience with options.  But I'd like, with this post, to share with you a trade I recently made that very succinctly answers a question I'd received while in the investment business.  Clients asked, "When I sell covered calls, how frequently may I experience early assignments?"

I use monthly options which always expire at the close of business on the month's 3rd Friday.  But a pre-mature (as I like to describe them) assignment of a call can occur anytime prior to option expiration Friday.  Quite frankly, they usually do not occur pre-maturely.  But when they do, I find, it's generally when the underlying equity (stock) is a dividend paying equity, & the call option is in the money (the equity's market price is higher than the option's strike price).  And when that's the case, the pre-mature assignment of a call generally happens on the business day before the ex-dividend date.

So, my trade:  To start with, on May 21, 2018, I sold a covered call against TLT, the ticker symbol for the US Treasury ETF.  TLT was trading around $117.  I sold the June 15, 2018 call, with a $118.50 strike price, & received a $0.55 premium.  But on May 31, TLT traded at $121.  And I knew that on on June 1, TLT would go ex-dividend on its $0.28 monthly dividend.  I suspected that the owner of the TLT June $118.50 call (the owner would have bought the call some time earlier from a seller like me) might want to exercise that call to become the buyer of TLT at $118.50 & importantly, to be eligible to receive that $0.28 dividend.  But by exercising on June 1, he'd be a TLT buyer on the ex-div date, the "without" dividend date, & he'd not be eligible for the 28 cent div.  However, by exercising on May 31, he'd be buying TLT "with" dividend, & be eligible for the 28 cents.  To capture the dividend, I knew that he might be motivated to exercise his in the money call on May 31.

I did not like the prospect of being assigned to sell my TLT pre-maturely on May 31, at only $118.50 (my strike price), when TLT was trading in the market for $121.  So I used what I call a repair strategy (most option traders call it a roll out).  In step #1, I bought back the TLT June $118.50 call, which I had sold on May 21, but I had to pay a rich $2.89 premium on May 31.  This closed out (terminated) my June $118.50 call.  In step #2, I immediately sold a TLT July 20, 2018 call, with a $119 strike price, for a richer premium of $3.04.  I pocketed the 15 cents in premium difference, & now have the potential for another half dollar in strike price.  For extending my strategy one month, I accepted the potential for another $0.65, which annualizes to a 6.5% return versus the original $118.50 strike price.  Not too bad a repair of an unwanted obligation.

Keep in mind, with TLT at $121 on May 31, the day of my repair, the new $119 call is still in the money & I could certainly be assigned pre-maturely.  But if I was forced to sell my TLT quickly at $119, well in advance of July 20, my annualized return would then be enhanced above the 6.5% return.  And to be honest with you, the market is very smart, & it probably would not allow me to get such an enhanced return so easily.

I hope this kind of blog is helpful.  Let me know.  Ask me questions.

Dave Skonieczki