Sunday, October 21, 2018
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)!
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Hi Neighbor (I'm in Milford, NH and spent many an hour cruising the Hampton Beach strip in my youth).
ReplyDeleteI'm enjoying reading your blog. I've recently started selling CC and CSP, trying to get down my mechanics and stock selection. I haven't used ETFs for this strategy but it is something that intrigues me.
How did your TLT trades fare where it was nearly straight up for the entire first half of 2019?
Thanks for your insights,
Dave
Thank you Dave, for enjoying my blog. Although my wife & I moved to NH in 2006 after raising our family in Vestal, NY, we had vacationed at Hampton Beach since 1988. Perhaps you cruised the strip right by us.
ReplyDeleteIn my 9/19/19 blog on "over diversification, plus hedging = flat returns," you'll see that I stopped using TLT. My last use of TLT options ended on option expiration Friday, 3/15/19. Not because I dislike TLT, but because I needed less diversification. Today, I focus, nearly 100%, on the selling of SPY options (with a sprinkling of EEM options).
I trade monthly options, & in response to your question about my TLT option selling performance in 2019's first half, I can provide that answer as it relates from option expiration Friday, 12/21/18 to option expiration Friday, 3/15/19. During this 3 month period, the 10 year US Treasury bond's yield dropped from 2.79% to 2.59%, & Treasury bond prices appreciated. Today, the 10 year US Treasury bond yields 1.80%.
When Fidelity (I retired from Fidelity Investments, Merrimack, in 2017), dropped its mutual fund minimums to $0, I bought small dollar amounts of 4 index funds to help me track my option selling performance; including FNBGX, the long term US Treasury index fund. From 12/21/18 to 3/15/19, my FNBGX total dollar value went from $35.06 to $35.53, an increase of 1.34%, or 5.36% annualized.
Over the same period, I sold TLT cash secured puts to help me to buy TLT shares, & then sold TLT covered calls to help me sell those TLT shares. My only actual ownership of TLT shares began on 1/18/19, when, via my sold puts, I was assigned to buy TLT at $121.50. My actual ownership of TLT shares ended on 2/15/19, when, via my sold calls, I was assigned to sell TLT at $121.00. Although my TLT share ownership lasted only one month, my TLT investment experience lasted the full 3 months because I was always invested via sold options for the entire period.
I owned 1,200 shares of TLT for that one month period, but to make calculation easy, I considered one TLT share.
Over the 3 month period, per one share:
3 put transactions netted $2.35 in premiums.
1 call transaction netted $0.90 in premium.
1 TLT dividend provided $0.27.
2 interest payments by my CORE/FDRXX money market fund provided $0.30. For a total period of about 45 days, my cash secured put requirement averaged about $138,000. While reserved in my CORE, this $138K earned an approximate 2.1% seven day money market fund yield that paid 30 cents a share.
Although, after a one month holding period I sold my TLT shares for only $121.00, I collected $3.82 per share in the total income noted above. $121.00 + $3.82 = $124.82 proceeds - $121.50 cost = $3.32 net gain/$121.50 cost = 2.73% or 10.93% annualized.
You said Dave, that you're "trying to get down my mechanics & stock selection." The primer that I authored, Selling Options...Simply Called and Simply Put, which is noted on this blog, is geared for the option selling newcomer & written in the same style as my blogs. It aims to teach mechanics, period (but not stock selection).
In my 3 month experience above, the US Treasury index FNBGX went up modestly, 5.36% annualized. TLT shares with dividends would have done about the same. As emphasized in my book's chapter 25, versus modest upside by the underlying TLT (similar to FNBGX), an option selling strategy should outperform somewhat; it did, at 10.93% annualized.
But with the 10 year US Treasury yielding 1.80% today, the underlying TLT (& FNBGX) has really gone through the roof since 3/15/19. Had I been trading TLT options since 3/15/19 in this "through-the-roof" environment for TLT (& FNBGX), my option selling strategy would have most likely done very well, but not as well as TLT (& FNBGX); as also noted in my book's chapter 25.
Thanks for the detailed explanation, David. Nice returns, and advertisement for your book!
DeleteIf I didn't cruise by you in Hampton Beach, I probably did in Merrimack. I worked at Fidelity (as a contractor) in 2011-2012, on the CRM tool you probably used every day.
Thanks again,
Dave
It sounds, Dave, like you worked for Fidelity that year on Contra's 1st floor in MMK. I worked on Contra's 2nd floor, in "phones," from 2006 - 2017. The best job I ever had. Check out my profile pic. I'll bet we crossed paths.
ReplyDeleteHi Dave. Hope all is well in Milford. You might enjoy today's post. Missing work, I'm considering teaching option selling. Dave Skonieczki
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