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A Covered Call That’s Long Volatility

Friday, March 10th, 2017 | Vance Harwood

Covered calls are an example of  positions that are short volatility.  I hadn’t thought of it that way until Sheldon Natenburg, the author of Option Volatility & Pricing  pointed that out in a fascinating interview in Expiring Monthly  (   A covered call position is profitable if the underlying equity stays the same or goes up, but in a big market downswing, when volatility spikes up,  the modest potential profits from a covered call are more than wiped out by the losses in the underlying.

Unfortunately it is usually expensive to hedge a short volatility position.  The two most common strategies have problems:  VXX typically has roll yield losses, and VIX/VXX options have significant time decay.  Recently I started looking at Barclays’ VQT ETN, a fund that is intended to be long volatility.  The chart below compares $1000 invested in SPY and VQT starting in September 3rd, 2010—VQT inception date.

$1k investment in SPY and VQT

In bull market phases VQT underperformed the S&P 500  by about 50%,  but during the -19.5%  drawdown in August 2011 VQT only dropped 3% before going on a short term volatility fueled binge that lifted it 20%.    The next chart shows the day-to-day percentage moves of VQT vs SPY since June 2011.

Daily percentage moves SPY vs VQT

When times are volatile, VQT shifts its investments to include more short term volatility—which lowers its correlation to the S&P 500 to about 50% or 60%.  In very quiet times, like the end of December/January VQT shifts to a almost pure S&P play—giving it the nearly 100% correlation you see at the right side of the chart.   The next chart is from the VQT prospectus, showing the backtested, theoretical performance of VQT since 2005

VQT vs S&P500 backtest to 2005

VQT looks almost tailor-made for covered call writing.  Its low drawdown behavior limits capital risk while its volatility is similar to the S&P 500.  Unfortunately, there are no liquid options available on VQT, so we’ll have to get creative in developing a covered call style position.  Since much of VQT’s composition is direct exposure to the S&P 500 I will use SPY options as logical building blocks.  A covered call is a short call position hedged with a long equity position.    Since brokers won’t accept a long VQT position as a hedge for a short SPY call and I don’t want to have naked calls, I’ll protect my short call position with long out-of-the-money calls—creating a call spread.     I’m not too concerned about losses on these credit spreads, because VQT is a natural hedge for the position, so I’m comfortable with a $2 spread in the option strike prices.

Profitability analysis:

Market Action VQT action SPY call credit spread action Overall Profit
S&P 500 strongly up Up, but not as much as S&P Worst case loss.  Loss is premium received at creation minus $2/ option pair Neutral to small loss
S&P 500 up Up, but not as much as S&P  Neutral to profitable, with profit equal to premium received at creation minus any in-the-money intrinsic value. Modest profit
S&P 500 down Down, but not as much as S&P  Profitable, keep full premium received at creation Neutral to small loss
S&P 500 strongly down Strongly up as volatility portion kicks in  Profitable, keep full premium received at creation Very Profitable


The spreadsheet that provides the VQT backtest data from March 2004, including all formulas is available here.


Stock Dividends

Tuesday, September 13th, 2011 | Vance Harwood

For updated information on SPY, IVV, and VOO dividends see this post.

Some dividend related info:

  • Excluding market action, Stock/ETF prices will drop by about the dividend amount when opening on their ex-dividend date.   The equity no longer carries the value of the dividend, so it drops in value.  The 500 stocks comprising the S&P index don’t go ex-dividend en-mass on the 17th, so the index itself does not show this effect.
  • If you’re short a stock when it goes ex-dividend you are on the hook to pay the dividend
  • If you are short options on a stock when it goes ex-dividend you do not pay the dividend
  • You don’t have to hold your stock until the record date to qualify for the dividend. You can sell your stock on the ex-dividend date and still qualify.  However, on record date you do need to have sufficient funds in your cash account or an appropriately funded margin account to avoid a possible free riding violation.
  • If you are short in-the-money (ITM) call options on SPY when it goes ex-dividend, your options will probably be exercised and your shares called away (or a short position created in your account if you don’t have sufficient shares in your account).   The threshold for exercise is an option premium of about 50% of the dividend amount, so approximately $0.35 per share this week on Thursday evening.   This reality short circuits many dividend capture schemes that hope to hedge the stock price with short deep in-the-money calls.  See here if you are interested in various dividend capture schemes.
  • The market price to sell call options (bid implied volatility) on ITM calls will be depressed this week until the ex-dividend date,  Puts will have inflated ask prices—the option market makers are blocking any free lunch opportunities.

Overview of dividend capture strategies

Saturday, February 25th, 2017 | Vance Harwood

I have written several posts on dividend capture strategies.

My favored, although far from perfect strategy:

Dividend capture with covered calls

Some approaches I don’t recommend:

SPY dividend capture ideas that don’t work

Dividend capture—three approaches to skip

Additional background and tools, and an example:

Dividend capture overview

Covered calls–are you ready?

Combo orders–maximizing profits on covered calls

DIA dividend capture: creating the position

DIA dividend capture: position close out

More questions about dividends?  See Top 10 questions about dividends.

My Schwab Christmas 2011 wish list

Tuesday, April 2nd, 2013 | Vance Harwood

Update:  Schwab has added weekly and quarterly option support to all of their trading platforms.  See here for more information.

Schwab has provided a peek under the tree for the account holders they think have been good:

Stocking stuffers (not available until January):

  • A 35% discount for TurboTax.  In your Schwab account online look for “Tools and Calculators” under “Guidance”, then look for “File with TurboTax”.
  • “Ask a TurboTax® tax expert one question for free.”  Look for the “Taxes” tab under Guidance and look for the Tax Tools & Resources box on the right

The big box

  • In early 2011 Schwab will introduce StreetSmart Edge™, their new flagship trading platform.   Among other things this platform will include, “Major options trading improvements, including the ability to trade weekly and quarterly options.”   I am assuming this package will replace at least one of their current advanced trading packages: StreetSmart Pro® and™—hopefully both.


Wish list

In case Santa Schwab is listening, here are few more things I would like to see under the tree:

  • StreetSmart Edge™ playing well with corporate firewalls
  • Ability for StreetSmart Edge™ to support daily options if the CBOE gets permission to support them
  • Charts that allow their data to be exported to a spreadsheet (Fidelity’s Active Trader Pro offers this very nice feature)
  • Greeks for VIX index options computed on their true underlying (VIX volatility futures), not the VIX cash index
  • Greeks computed correctly for weekly options (Fidelity currently has the time until expiration screwed up)
  • Actual market makers for the listed options on Schwab’s no-commission, no fee ETFs.   The options are there, but the bid/ask prices are basically stub quotes.
  • Ability to short Schwab’s no-commission, no fee ETFs inside a Schwab account.    Schwab is showing these ETFs, which have very low short interest, as “Hard to Borrow.”   More likely don’t want to loan…
  • Charts on options
    • That exist
    • That don’t go away as soon as the option expires, and don’t lose their intra-day data soon after they expire
    • That offer the choice to chart bid/ask prices (let’s say at 15 minute intervals) instead of trades, so that useful charts aren’t so dependent on option volume.  This would be a chance for Schwab to jump ahead, after being behind for a while in supporting active traders
  • Allow option spreads in IRA accounts.  This might be possible already, but limited risk spreads should be a no-brainer when you already allow long calls / puts.
  • In IRAs have the Ability to leg-in / leg-out of option spread positions with combo orders
  • Other wishes out there?

Get weekly updates on the Weeklys

Monday, January 21st, 2013 | Vance Harwood

The CBOE has announced a nice new email service for people wanted to know what weekly options are going to be offered each week.  While the list has been relatively stable the CBOE recently extended the list to 35 offerings and they usually make a few tweaks each week.   For example, they recently dropped USO in favor of NDX—something I’m not happy about.

They plan to send out an email, typically on Wednesday, listing the options they plan to list starting on Thursday.   To sign up use this link and look for the Weeklys option selection near the bottom of their list of available newsletters.   If you already have a CBOE login you can add this email update here.

Click here for more information on weekly options.