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Playing the weeklies…

Monday, July 19th, 2010

Created a covered call position today with SPY at 106.89 and 107 SPY calls expiring this Friday–the 23rd.   The calls sold (to open) at 1.18, giving a 1.2% best case profit for the week if SPY closes Friday above 107.   Fidelity supports trading these weekly options, but apparently Schwab does not.

Posted in Covered Calls, Options, all | View Comments

Weekly options for the masses–SPY, QQQQ, IWM, DIA and others

Wednesday, July 7th, 2010

Anyone that trades options knows that the pace quickens the last few days before expiration.   The delta (the change in option price relative to the underlying)  for the ATM option is still around .5, but instead of gradual changes for the deltas on the strikes in / out of the money, the curve starts resembling a step function, going from zero for out-of-the-money, to one for in-the-money at expiration.   The time decay of the option premium (theta) also accelerates, with perhaps 50% of the decay in the last month happening in the last week of the option’s life.

Taken from http://www.option911.com/blog/option-education/how-option-time-premium-decays-over-the-weekend/, click to enlarge

Taken from http://www.option911.com/blog/option-education/how-option-time-premium-decays-over-the-weekend/, click to enlarge

All of this is of course modulated by any changes in the volatility of the underlying, and the market in general.

Some traders avoid options close to expiration because of these factors–and others flock to them.    As a covered call writer I am really attracted to the accelerated time decay of short term options.   I’m not taking any more risk than normal holding the underlying, and I am getting an accelerated decay in the price of the options I am short on.    I will often wait until there is only two or three weeks are remaining on the options to create the position.

Now it can be expiration week, every week for the following Stocks / ETFs (taken from this CBOE posting):

Weeklys on Exchange Traded Funds and equities. As of July 5, 2010, these included the following::

  • SPY – Standard & Poor’s Depositary Receipts
  • QQQQ – Nasdaq-100 Index Tracking Stock
  • IWM – iShares Russell 2000 Index Fund
  • GLD – Options on SPDR® Gold Shares
  • XLF – Financial Select Sector SPDR
  • EEM – iShares MSCI Emerging Markets Index
  • C – Citigroup Inc
  • BAC – Bank of America Corp
  • AAPL – Apple Inc
  • BP – BP PLC
  • F – Ford
  • GOOG – Google Inc.

Fidelity supports trading on these new weekly options, but Schwab does not appear to.   Beware of the listed greeks on these options, the software may not be using the correct time until expiration.

The volume, at least on the SPY weeklies has been substantial (20K today on the 105′s expiring 9-July), so I think the options providers have a winner.

For more information see this options clearing house post.

Posted in Covered Calls, Dividend Capture, Options, all | View Comments

More on SPY

Tuesday, May 18th, 2010

Bought SPY at 114.69, sold-to-open 116 May calls at .58

Posted in Advanced Topics, Covered Calls, all | View Comments

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

Thursday, April 15th, 2010

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, Covered Calls, Dividend Capture, Options, all, dividend, ex-dividend | View 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, Covered Calls, Options, all | View 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 my next post I’ll give some screening criteria for good positions and the basic setup of this dividend capture strategy.

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

    Covered call on SDS

    Thursday, February 25th, 2010

    Did covered calls on SDS (double short S&P 500).  Bought SDS at 35.86, sold March 34 calls at 2.37 for a net investment of 33.52.    Extrinsic value is .48, so the max profit potential is  .48/33.52 = 1.4%

    Posted in Advanced Topics, Covered Calls, Options, all | View Comments

    Out of Oil and SPY

    Monday, February 22nd, 2010

    My USO position and my remaining SPY covered call positions were called this weekend, so I’m back to about 90% cash.  Despite the scary stuff in the last couple of weeks, they ended up yielding their maximum profit potential.

    Oil looks expensive right now, so I wouldn’t be surprised to see a pull back there.   The S&P 500 could certainly go higher with this rally, but looking at the 250 day chart the resistance level at 111 really stands out.  This one could be tough to break through. Click chart to enlarge.

    SPY22Feb10

    Posted in Advanced Topics, Covered Calls, Mainstream, dividend, ex-dividend | View Comments

    DIA dividend capture

    Friday, February 12th, 2010

    The SPDR Dow Diamond ETF is an interesting candidate for a dividend capture strategy–if you can do it in a tax sheltered account such as a traditional or ROTH IRA.   On an annual basis is it yielding around 2% and it distributes dividends monthly.  Its dividend payouts are not consistent month to month, they vary from an average of  $0.11 in January over the last 5 years, to and average of $0.33 in October.  The chart below gives details.   February’s average payout is around $0.25, which is pretty close to a .25% return since the DIA is around $100 per share right now.

    DIA is unusual for a index ETF offering monthly dividends, in that its ex-dividend dates are the day before the option expiration date for that month.  For example DIA goes ex-dividend on 19-February and the last day of trading on the options is also the 19th with expiration on Saturday the 20th.

    This arrangement sets up a straightforward dividend capture scheme using covered calls.   You buy DIA and sell DIA ITM calls, with an extrinsic  value (time value) of approximately the dividend value (historically about 0.25 for February).  At closing today, with DIA at $101.5, this would suggest the 98 Feb call, which at $3.75 would give the target extrinsic value.  The break-even point on this position will probably be 101.5-3.75 =97.75.  I say probably, because there is uncertainty on whether you collect the 0.25 per share dividend or not.

    Read More

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

    Feeling bullish — putting more down on SPY

    Wednesday, February 3rd, 2010

    Still feeling like there is some upside in the market.   Bought SPY at 109.94, sold Feb 109 calls at 2.31 for a net investment of 107.3.  Looked at the 110 calls, but they only had about 0.30 more premium on them, so I opted for the higher insurance value of the ITM 109s.    With the 109s the extrinsic value is 1.37 or 1.3%

    Posted in Covered Calls, all | View Comments

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