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Lots of premium available on SPY options

Thursday, May 13th, 2010

There is a lot of premium available on SPY options that will expire at the end of next week due to the recent market gyrations.   I created a covered call, buying SPY at 117.26, selling-to-open May 117 calls at 1.69 for a net investment of 115.57.   The Theta (time decay) on these options is $8 per day.

Posted in all, Covered Calls, Options | No Comments »

Doubling up on Oil, betting on VIX dropping

Tuesday, May 11th, 2010

Did covered calls on Oil — bought USO at 37.19, sold-to-open May 37 calls at 1.02 for a net investment of 36.18.

Created a bear spread on VIX options today.   Betting on VIX going down is forecasting that the market in general will be flat or positive.  I sold-to-open June VIX 16 calls at 10.26, bought  June  VIX 32.5 calls at 1.88 for a net credit of  8.38.  I was able to approximately split the bid/ask prices with my combo order.   At the time of the order the spreads were approximately 10.00 / 10.60 on the June 16 options and 1.80/1.95 on the June 32.5 calls.  Going with the published bid/ask prices leaves money on the table.

The VIX cash index was around 28.5 at the time my order filled.   I initially tried to go short on VXX, but Schwab had VXX in the “hard to borrow” category this morning.   I suspect lots of people were trying to short the VXX today.   I went with June options rather than May because there are only 7 days left on the May VIX options–I wouldn’t be surprised at all to see one more down leg in this correction.    I expect the June options will move much down much slower than the VIX index as the market moves away from fear mode.

Posted in Advanced Topics, all, Covered Calls, Options, VIX | No Comments »

Back into Oil

Friday, April 30th, 2010

I did covered calls on USO,  selling-to-open the 41 May calls at 1.33 and buying USO at 41.47 for a net investment of 40.17.    The US economic situation continues to look up, and the oil spill in the Gulf will do nothing to help the supply situation.  Plus it gives companies an excuse to raise oil prices…

Posted in all, Covered Calls | No Comments »

Bull Spread — SPY at 121.0

Friday, April 23rd, 2010

One alternative to a covered call is a bull spread.  You give up some premium in exchange for significantly reducing your downside risk.  I bought SPY 118 May calls at 3.91 and sold 121 May calls at 1.82 for a net debit of 2.09.  SPY was right at 121 at the time, so the the 121 calls were right at the money–which is the  maximum premium point (the 120 and 122 calls had about .45 less premium).  Maximum profit on this trade is 0.91,   maximum loss is the debit amount — 2.09.

Posted in Advanced Topics, all, Covered Calls, Options | No Comments »

Dividend capture with covered calls—too hot, too cold, or just right!

Thursday, April 15th, 2010

If you have general questions about dividends see Top 10 questions about dividends.

One strategy for capturing dividends is to buy the stock/ETF and then sell calls against that security as a hedge—a covered call.  The value of the short calls moves in the opposite direction of the stock/ETF, providing a hedge.   There are three major variables with this strategy:

1. How many days before the ex-dividend date do you put the position in place?
2. What strike price do you select for the options?

3. How many days until the options expire?

Your risk profile, playing with these variables, can be generalized into the three situations below:

Too cold (too low a risk)    Calls too deep in the money
  • If you sell deep in the money (ITM) options you may feel you’ve found the golden goose.  The calls provide a great hedge, virtually eliminating risk from your position.   Unfortunately, your calls will almost certainly be assigned the evening before the ex-dividend day.  The owners of the calls are not about to let you get away with collecting dividends with such low risk, so they exercise the option you sold them.  They call away your stock and they collect the dividend.  Your position is closed out—no dividend for you.  The only profit you might have is from any premium present when you created the position (if your net investment was less than the strike price).   Some people use this strategy hoping that their options will not be assigned, and not all are, but in my experience the percentage not assigned is very low.

Too hot  (too much risk)    Calls without enough hedge value,  calls that don’t expire for a long time

  • If you sell options that have a strike price that is at or above the current market price of the stock/ETF you can collect a significant premium, and signficantly lower the risk of having your stock assigned.  However, since the value of the options is relatively small (perhaps .5% of the value of the stock) you don’t have much downside protection.   A few bad days on the market can wipe out a year’s worth of dividend capture profits.
  • Not having your stock assigned is good from a dividend collection standpoint, but it is bad if your options have weeks until they expire.  If your calls have a while to run you will see the premium on your unassigned options increase by about the amount of the dividend on the ex-dividend day.   Since you are short these calls your net profit on ex-dividend day will be about zero.   Until the premium on the option decays away, ultimately going to zero at expiration, your position is usually not profitable.   While you wait for the premium on the call to decay you are exposed to market risk—this can be very unpleasant.

    • Just right
    • What I have found to be a good combination is:
      • Find stocks/ETFs where the options will expire within 10 business days of the ex-dividend date
      • Create the covered call position about a week before the ex-dividend date
      • Choose a strike price that gives you a premium about equal to the dividend value.
    • This recipe will usually result in a covered call position that will be assigned on the evening before the ex-dividend date.  You typically don’t collect the dividend, but since the option is closed out you keep the option premium which is roughly equal to the dividend amount.
    • The calls will provide a decent hedge against risk.  Not enough to protect against a major market move, but they do provide significant protection
    • If the stock/ETF value goes down after you put the covered call in place then the chances of call assignment decrease—bettering your chances of collecting the dividend.  If you do collect the dividend  the breakeven point on your position is improved, and your maximum profit potential goes up by the dividend amount.
    • If the bid / ask spreads on the stocks / options are significant you will probably need to use a combo order to get a decent profit potential.
    • While ok in flat or rising market—this position will not hedge a serious bear move—be prepared to bail out if the market goes seriously south

    Related posts

    Posted in Advanced Topics, all, Covered Calls, dividend, Dividend Capture, ex-dividend, Options | 8 Comments »

    Betting that the rally will last the week

    Tuesday, April 13th, 2010

    Did covered calls on SPY,  buying SPY at 119.70,  selling to open April 119 Calls at 1.11.   Net investment/ breakeven is 118.59.   Ended up doing sequential market orders because combo order execution was not working well at Schwab.  Has the feel that actual humans are involved in the process–not a good thing with a moving market.

    Posted in Advanced Topics, all, Covered Calls, Options | No Comments »

    Understanding covered calls—an analogy

    Monday, April 12th, 2010

    I know that analogies usually confuse more than they help—but that’s not going to stop me from trying…

    Imagine that you are the season ticket holder of 4 good seats for a major league football team at the beginning of the season. A lot of people think the team is headed for the Superbowl, but you are pessimistic. You’d like to cash in on the current hype and get some money now for the last home game of the season. On craigslist you offer to sell the rights to this game. Your offer doesn’t force the buyer to buy the tickets, but gives the buyer the right to buy the tickets from you at face value any time before the game.

    If your team is undefeated 4 games into the season the value of your offer will go up. If the last game of the season determines whether the team goes to the playoffs or not your offer could become quite valuable–essentially the difference between what the scalpers are charging for comparable tickets and the face price of the tickets.

    On the other hand, if your team is near elimination from the playoffs halfway through the season your offer will be almost worthless—who would pay money for the right to buy tickets at face value that will probably be cheap on the street? If the last game of the season ends up being a meaningless contest between two loser teams you will probably have to sell your tickets at a discount if you don’t want to go yourself.

    Your offer on Craig’s list has similar characteristics to selling stock options on stock you own—a covered call. You give up the upside on an asset you own in exchange for money upfront. No laws of nature have been broken—relax…

    Posted in Advanced Topics, all, Covered Calls, Options | No Comments »

    Will the rally last?

    Monday, April 12th, 2010

    Did a covered call on SPY using a combo order.   Bought SPY at 119.83, sold-to-open  April 120 calls at $0.70 for a net investment of 119.13.

    Posted in Advanced Topics, all, Covered Calls, Options | No Comments »

    Capturing dividends with covered calls—are you ready?

    Tuesday, April 6th, 2010

    In a recent post I gave an overview of dividend capture strategies.

    In some situations an effective way to hedge risk with a dividend capture strategy is to use covered call options.  If you are not familiar with options this might sound exotic, but it’s truly the training wheels of option trading.  With covered calls you can introduce yourself to the conservative, hedging possibilities of options while increasing your odds of making modest amounts of money.   Before getting into the details,  please review the checklist below, to see if you are ready / able to do this:

    • Do you have enough capital?
      • This strategy requires you to buy hundreds of shares of stock to make it worth your trouble, do you have the money?
      • You can use margin to buy the stock, but that will increase your costs.
    • Will you be content with a small gain?
      • This strategy is generally not effective with stocks with large dividends (e.g. 4% or higher).  It works better with stocks that offer annualized dividends in the 2% to 3% range
      • On the good news side, you generally get the small gain with less than 10 business days of investment
    • Does the stock/ETF you want to capture the dividend on have a active option market?
      • If the options are thinly traded, or if appropriate strike prices are not available this strategy does not work
    • Are you set up for at least the first level (simplest level) of options trading in your brokerage account?
      • If your account is not an IRA then you will need to have a margin account.  Don’t worry, there are no interest charges or chance of a margin call with this strategy (assuming you don’t buy the stock on margin)
      • This first level of option authorization usually allows covered calls and simple purchases / sales of puts and calls
      • Typically you can do these sorts of trades in a Roth / Traditional IRA — however you do need to apply for that capability if you don’t have it already
    • Are you willing to learn about combo orders? These are orders that simultaneously fill your stock and options orders at a not-to-exceed price
      • These orders are prudent to use in fast moving markets, and when bid/ask prices are widely separated
      • Combo orders are not necessary if bid/ask spreads are small and if you are willing to do fast sequential market orders

    Extra Credit

    • Can you make your investment in an IRA account?
      • If so, this dividend strategy is more attractive, because you can defer taxes on any gains

    Pass the test?  In this post I’ll give some screening criteria for good positions and the basic setup of this dividend capture strategy.

    Posted in Advanced Topics, all, Covered Calls, dividend, Dividend Capture, ex-dividend, Options | 1 Comment »

    Dividend Capture Strategies

    Saturday, April 3rd, 2010

    In trying to capture dividends there is no free lunch. In fact, since Wall street is involved, the best you can hope for is an affordable lunch. I have looked at, and tried quite a few approaches—most of which don’t work, but I have found one approach that does work with some ETFs. Ironically you don’t actually collect the dividend most of the time, but you can collect an amount similar to the dividend-with a reasonable amount of risk.

    Anyone with money can capture a dividend—you buy the stock (or ETF) before the ex-dividend date and hold it until the ex-dividend date. The challenge is to close out your position with a profit that is worth the risk. Typically the stock will drop by about the dividend amount when it starts trading on the ex-dividend day, but if the stock has a generally up day your overall profit can be better than the dividend. You lose money if the stock drops by more than the dividend amount (ignoring commissions)—and if the market goes bad you can lose many months worth of dividends in a hurry.

    There are two ways to deal with this kind of risk, you can try to predict the future, or you can hedge. If you are any good at predicting the future then you don’t need to be messing around with dividends, you should just be buying and selling based on your predictions. With hedging you try to reduce, or better yet eliminate your risk by also investing in something that moves in the opposite direction of the stock so that the price movements cancel out. Some high quality hedges for a stock or ETF:

    1. Sell the stock short
    2. Sell a stock short that very closely tracks the stock you own (e.g., IVV for SPY)
    3. Buy an ETF that has an inverse relationship to your stock  (this can be done in IRAs, they don’t allow shorting)

     

    Hedges that can reduce your risk, but only provide medium protection include:

    1. Shorting the general market or industry sector that your stock is in
    2. Buying inverse ETFs for the general market or industry sector
    3. Use stock options with strike prices close to the current market price
    4. Use stock futures (sell futures)

     

    The folks on Wall Street aren’t about to let you get away with any sort of risk free profit, even if it is only a few tenths of a percent.   The high quality hedges above don’t work at all (see here) for dividend capture.   The medium level hedges don’t eliminate the downside risk and introduce the possibility that an upside move by your stock might be more than wiped out by an even stronger downside move by your hedge.

     

    I have used one approach that offers a reasonable payoff, with reasonable risk—using deep-in-the-money stock option calls to capture the dividend amount.   More about this in this post.

    Posted in Advanced Topics, all, Covered Calls, dividend, Dividend Capture, ex-dividend, Mainstream, Options | No Comments »

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