don't sellputsthencalls to "get-rich-quick"

Investors may ask me, "How's your option selling strategy doing?"  Or, "Is it better to sellputsthencalls or better to simply buy-&-hold?"  I've observed option selling advocates boast that the strategy is an easy way to make a lot of money, especially since, as they proclaim, "75-80% of options expire worthless, & therefore, the option seller simply collects premiums 75-80% of the time.  No assignments to buy or sell the underlying, 75-80% of the time!  Almost like free money." 

I sell monthly options against ETFs in my IRA & after each 3rd Friday's expiration, I measure my month's performance & annualize the performance.  Over the most recent 9 months that cover option expiration Fridays 3/15/19 through 12/20/19, I sold options against 3 ETFs:

• SPY, the S&P 500 index.
• DIA, the Dow Jones Industrial Average.
• EEM, an emerging markets index.

I didn't use all 3 ETFs in each of the 9 months.  I used SPY in 5 of the months & DIA in the other 4; never together.  I only used EEM in each of the last 6 months.  When I used EEM, my allocation with it was only about 5%.

In my sellputsthencalls strategy during this period, along with selling puts & covered calls to open, I also repaired puts & calls.  I sold options 20 times.  12 of these 20 expired worthless = 60%.  Not 75-80%.  That low 60% ratio is typical for me because I often sell options that are only slightly out-of-the-money.  I do so to receive higher premiums.  Consequently, I receive more assignments. 

In reporting my option selling performance for 3 of those 9 months, I could easily boast that I'm "getting-rich-pretty quickly:"

• July, +16.7% annualized.
• October, +16.8% annualized.
• December, +16.1% annualized.

But in reporting my option selling performance in 1 of the months, I must admit that I'm "getting-poor-very quickly:"

• August, - 42.9% annualized.

To be fair & accurate, however, I compare these performances against appropriate indices:

• I own a small parcel of FXAIX, Fidelity's S&P 500 index fund, in my IRA.
• I keep track of the .DJI, the index for the Dow Jones Industrial Average.
• I own a small parcel of FPADX, Fidelity's emerging market index fund, in my IRA.

The comparisons (only made against the indices that I used in that month):

July

• option selling, +16.7% annualized.
• FXAIX, +11.3%.
• FPADX, +4.9%.

October

• option selling, +16.8% annualized.
• FXAIX, -7.0%.
• FPADX, +12.5%.

December

• option selling, +16.1% annualized.
• FXAIX, +36.3%.
• FPADX, +57.9%.

And August

• option selling, -42.9% annualized.
• .DJI, -60.9%.
• FPADX, -101.3%.

For the entire 9 month period, 3/15/19 through 12/20/19 (The annualized performance numbers for the 3 indices presume that I had held them for the entire 9 month period.  As noted above, I did not.)

• option selling, +13.7% annualized.
• FXAIX, +21.3%.
• .DJI, +13.4%.
• FPADX, +9.3%.

The above comparisons are not perfectly "apples-to-apples," but they provide a decent contrast.  A better "apples-to-apples" comparison is provided for my 6 month EEM investment, covering 6/21/19 through 12/20/19:

• option selling versus EEM, +20.4% annualized.
• FPADX, +13.2%. 

If you sellputsthencalls, don't expect to "get-rich-quick."  Expect your option selling performance to compare as follows to these buy-&-hold performances that use your underlying stock:

• Buy-&-hold through the roof?  Options do very well, but not as well.  This underperformance is painful for me, as in December, above.  The compromise of option selling.  But to avoid this compromise, I'd need to buy-&-hold; or buy call options.
• B&H up modestly, flat or down modestly?  Options generally outperform.
• B&H into the tank?  Options also lose, but not as much.  Don't under-appreciate "losing less."  If B&H produces a 20% into the tank loss from $10,000 to $8,000, it takes a 25% return to get back up to $10,000!  When you sellputsthencalls, you're hedging against market losses.

Lesson 2: selling covered calls to "sell high"

In Lesson 1, as an application of my sell puts, then calls strategy, I presented the selling of the November $140 cash secured put against FDX (Fedex) in my effort to "buy low." FDX was trading at $140.11 then & I thought it might drop below $140, forcing on me the obligation to buy FDX at the $140 strike price.  I wouldn't have minded doing so because FDX had been over $200 recently, & to boot, I received a $5.60 premium for selling that put.  The $140 strike price - $5.60 = $134.40 net cost represented quite a discount to the $140.11 market price. 

A few days later, FDX dropped as low as $138.38, but a premature assignment forcing me to buy FDX at $140 never occurred.  Since then, FDX has gone-through-the roof.  Today, it traded at $164.66.  My experience since October 2 exhibits one of the compromises of selling puts:  in a strong market, the put seller's gain is limited to the premium received.  The $5.60 represented 4%; 33% annualized.  That's superb, but had I simply bought FDX instead of selling puts, my position would have been up over $24 today!  That $140 put that I sold expires on November 15, & unless FDX tanks to under $140, my sold put will expire worthless, we say.  The $5.60 (plus the money market fund interest on my $14,000 reserved cash) is my only gain.

This brings me to Lesson 2.  Last week, FDX traded at $155.  Chasing the lost opportunity above, let's presume I bought 100 shares of FDX then, at $155.  With FDX at $164.66 today, my reward on last week's buy is handsome.  FDX is up over $8 today, but my fear is that it will pull back.  Yet, I know that it may continue driving upward.  Should I sell FDX?  Should I hold & earn the $0.65 quarterly dividend (1.58% current yield)?  When I'm thinking about selling my stock, I generally think about selling a covered call against it to help me "sell high." So let's review FDX's call option chain when it traded earlier today while FDX was at $164.66:       
              



I'm going to selling the $165 covered call against my FDX shares.  It expires on December 20, 2019, 46 days from now.  I'll receive the $6.75 BID from the call buyer as my premium for selling this call.  Since I own only 100 shares of FDX, I'll sell only one of the December $165 calls against my position.  One call (generally) controls 100 shares, so my total premium = $675.  This $675 settles into my money market CORE tomorrow.  It's non-forfeitable.  I can use it for living expenses, to buy more securities, or to collect money market fund interest on it.  But (like the premium received from selling the FDX put on October 2), this $6.75 is not free.  I now have an obligation to sell my 100 shares of FDX at exactly the $165 strike price, if FDX is higher than $165 over the next 46 days.  If FDX goes back up to over $200, all I get is the $165 strike price; one of the compromises of selling covered calls.  However, I would be "selling high:"  $165 + $6.75 = $171.75; higher than today's $164.66! 

If FDX stays below $165, my covered call expires worthless on December 20 & all I will have earned is today's $6.75 premium; I would not be obliged to sell my FDX shares.  After the December 20 expiration, I can then sell another covered call against FDX, perhaps a call that expires in January, or later in 2020. 

While owning FDX, I'm eligible for its 65 cent premium, paid every 90 days.  Some investors consider the premium received by selling covered calls a nice complement to the stock's dividend.  Today's $6.75/$164.66 = what I call a 4.1% premium yield over 46 days; over 32% annualized.  If I were to guess that today's $164.66 price had a good chance of exceeding $170, I might sell the $170 call instead, & settle for the smaller $4.50 premium. 

By the way, if I sold this December $165 (or $170) call, since I already own the FDX shares, the option is called a "covered" call because if I'm assigned by obligation to sell 100 shares of FDX, my obligation is "covered" by the 100 FDX shares in the account.  If I sold the call without having the 100 FDX shares in my account, the option is called a "naked" call, & a margin agreement would be required in my account to facilitate the potential for borrowing.     

              

selling options...better than buy & hold?

It's easy to cherry-pick performance & make any strategy look good.  But with option selling, performance comparisons are very objective.  In chapter 25 of my primer Selling Options...Simply Called and Simply Put (noted on this page), I review 5 outcomes for an option's underlying stock & compare them to selling options versus the underlying stock.  The 5 outcomes are through-the-roof, up modestly, flat, down modestly & into-the-tank. 

In response to my one year old post of 10/21/18, "Flexibility, creativity...," another Dave asked me on 10/24/19 how my option selling versus TLT (the I*Shares ETF that holds long term Treasurys) worked when TLT shot up dramatically in the first half of 2019.  I had piqued his interest in my year old post of 10/21/18, when I reviewed a 24 day period in which I could have done nothing (similar to buy & hold) with my existing, sold, TLT covered call; & compared doing nothing versus the TLT covered call repair that I actually made.  During this 24 day period, the 10 year US Treasury yield rose from 3.10% to 3.20% & TLT dropped nearly $3 a share.  Had I done nothing, my strategy would have gone into-the-tank, losing 2.21% over the 24 days, or 33.54% annualized.  But by repairing my covered call & generating a premium credit, my option selling strategy still got beat up, but not as much - it dropped 1.59% over 24 days, or 24.14% annualized.  The covered call repair that I made provided a modest hedge against rising interest rates & falling bond prices.

To answer "another Dave's" query, I could only review the 3 month period ending on 3/15/19.  During this 3 month period, the 10 year US treasury yield dropped from 2.79% to 2.59% & TLT appreciated.  I compared TLT option selling versus FNBGX, the Fidelity index fund that's a good proxy for TLT because both invest in long term US Treasurys.  During this 3 month period, FNBGX went up modestly, 1.34% or 5.36% annualized.  Selling options against TLT fared better, up 2.73% or 10.93% annualized. 

By the way, the 10 year US Treasury yields only 1.80% today; TLT has gone through-the-roof since 3/15/19.  It's reasonable to say that if I had been selling TLT options since 3/15/19, my strategy would have done well, but hardly as well as buying & holding TLT. 

Option selling, in general, should beat 4 of the 5 outcomes above, losing only to through-the-roof.  But it doesn't prevent an investor from losing money!           

Lesson 1: selling puts to "buy low"

A couple weeks ago, Fedex Corp tanked dramatically.  Even though I prefer selling options against ETFs like DIA & SPY, I was tempted to look at FDX (Fedex) puts.  FDX is an economic bellweather & it dropped from about $174 to $148 on that September day.  FDX traded at $234 last December, & at $274 in January, 2018.  Puts on individual equities like FDX offer premiums that are much higher than ETFs' put premiums.  I didn't make the trade last month, but with FDX at $140.11 today, down $1.53 or 1.1%, it provides a good Lesson 1.  Here's FDX's put option chain at this time:

As a put seller, I want to position myself to buy FDX "low," rather than at the current $140.11.  I can sell the $140 put that expires on November 15, 2019 (November's 3rd Friday) & receive a $5.60 premium, the put option's BID price.  Each put contract controls 100 shares (100 X $5.60 = $560), but let's simplify the lesson by considering one share (& no commission).  Because I'm a seller of this put option, I must receive cash, the $5.60 premium.  (Of course, the buyer of this put must pay cash.)  The $5.60 hits my account on this put trade's settlement day, tomorrow.  It's non forfeitable, it's mine.  It collects interest, can be used to purchase other securities, can be withdrawn.  But it's not "free." In return for the $5.60 that I receive, I accept an obligation to buy FDX if it drops below the $140 strike price between now & the close of November 15, a 44 day period.  If FDX drops to $139, $130, $100, or even to $0, I'm obliged to buy FDX for exactly $140, the put's strike price.  But if I pay the $140 strike price for FDX, is not my real cost $140 - $5.60 = $134.40?  Buying FDX at $134.40 is buying it "low" relative to today's $140.11; more than 4% lower.  If FDX drops to $130 or $100 or $0, I'm hurting.  But not as much as if I had bought FDX outright today, at $140.11.  Now if FDX stays above $140 over the next 44 days, I will not be obliged to buy FDX & my put contract expires worthless.  My obligation to buy FDX at $140 ceases.  All I'd receive in this case is the $5.60 premium that I earned on trade day.  By the way, when I sell this put, to protect myself & my broker/dealer from a large FDX drop during the 44 days, I reserve $140 per share in my account's CORE position to finance the obligation of having to buy FDX at $140.  ($140 X 100 shares in a put contract = $14,000 on reserve.  This $14,000 earns interest in my money market fund, but the $14,000 can't be used otherwise.)  I'm selling a cash secured put in this Lesson 1 (not a naked put that requires margin availability).  If FDX stays above $140 (even if it goes back up to $274) by November 15's close, all I earn is $5.60.  If so, $5.60/$140 on reserve = 4.0% for 44 days; over 33% annualized.  To accept less risk, I can sell the $135 put & receive a $3.65 premium = 2.7% for 44 days; over 22% annualized.  With even less risk, the $130 put pays a $2.33 premium = 1.8% for 44 days, nearly 15% annualized.  What I like about selling puts (& calls), is that you can actually feel the risk, measure the risk, & then choose the strike price that satisfies your want & your tolerance.                      

covered call, in the money, ex-dividend?

I often sell monthly covered calls against DIA, the ETF that holds the 30 Dow stocks.  DIA pays a monthly dividend.  Its current yield is around 2%.  The ex-dividend date is always option expiration Friday, which is tomorrow, September 20, 2019.  My current DIA September 20, 2019, covered call has a strike price of $267.  Today, DIA's at $271.42, & my call's $4.42 in the money.  With dividend paying equities like DIA, in the money calls are often assigned against the call seller on the day prior to ex-dividend date, which is today, September 19.  If this happens, I'll be assigned to sell my DIA today, at $267, & because ex-dividend is not until tomorrow, I'll lose my monthly dividend.  As part of my monthly routine when my covered call is in the money, today (one day before ex-dividend date) I considered a one month repair strategy to avoid the premature assignment of my covered call & loss of my dividend:  buying back the September $267 call at the $4.60 ASK & selling the October 18, 2019, $269 call at the $4.90 BID, pocketing the 30 cent credit.  In my evaluation of this repair strategy, I calculate my potential annualized return.  I don't know which way DIA will move over the next 29 days, so I presume that DIA stays at $271.42 for this calculation.  If DIA stays flat, I'll be assigned to sell at $269 on October 18.  $2 strike price appreciation + $0.30 premium credit = $2.30 return.  $2.30/$267 = 0.86% which annualizes to 10.8%.  Add DIA's CY of 2% = 12.8% potential for the repair strategy.  My new October $269 call would still be in the money with today's repair, and premature call assignments generally do occur on the day before ex-dividend which is today, but it's reasonable to dismiss this concern until the next ex-div date which is October 18.  (It is unlikely to see my new October $269 call assigned today because then I'd receive the extra $2.30 repair return almost instantly!)  In comparison to the repair strategy, I considered allowing my September $267 call to be assigned today, obliging me to sell my DIA at $267.  If so, tomorrow I'd sell a DIA, October 18, 2019, cash secured put.  At today's pricing, I'd sell the $271 put, at a $3.60 BID.  $3.60/$271 (the cash secured put's reserve requirement) = 1.33% which annualizes to 16.7%.  Today, because I presume a flat market - I must do so since I don't know it's direction - I chose the put strategy at 16.7% over the covered call repair strategy at 12.8%.

over diversification, plus hedging = flat returns

From August, 2017, to March, 2019, I sold monthly puts, then monthly calls against 4 ETFs.  The puts helped me to buy low & the calls to sell high.  My allocation target was 40% SPY (S&P 500), 15% EFA (developed foreign markets), 10% EEM (emerging markets)  & 35% TLT (long term treasurys).  Each ETF was very diversified.  Therefore, I was very diversified in the world's equity & bond markets.  Perhaps, nearly perfectly diversified!  Plus, by selling options against the ETFs, I was always hedged.  The diversity of the 4 ETFs protected me from high volatility.  The option hedging protected me from high volatility.  My performance was very modest compared to the markets covered by the ETFs.  At times, I beat the markets by a little. At times, I lost to the markets by a little.  Overall, although I made money, I slightly underperformed the markets.  Since March, 2019, I've sold puts, then calls against either SPY or DIA (Dow Jones Industrial Average), exclusively.  Nearly 100% allocation in US large cap equities.  With left over cash availabilty, I've sold puts, then calls against EEM, to provide some extra premium pop.  My performance has been in line with what's to be expected from option selling.  Against very strong markets, I've done well, with some underperformance.  Against very weak markets, I lose, but I lose less.  Against markets that are flat & slightly up or down, I tend to outperform.