Over the years I have explored many branches of investing, reading books by and about successful investors as well as traders and speculators. I was totally turned off by day trading, it requires a degree of attention to multiple screens and activity tracking way beyond my attention span. On the other hand, selling covered calls is a leisurely business.
The Captain
I thought you were studying both sides, the house and the gamblers, and things rigged in the houseâs favor and that you can be the house instead of the gambler by selling calls, and so on.
And then that you also need to understand volatility, which one side buys from the other.
Not really. With stocks the market sets the price and investors take it or leave it. With options the seller can pick the best option to sell and the buyer takes it or leaves it. This is what I mean by the house sets the rules.
I confess I donât understand what selling volatility means. There is no such derivative that can be traded in markets. Stock, futures, options, yes.
The Captain
There is at least one such derivative: equity option.
For example,
There is, for example, VXX which is an ETN that follows VIX futures. VXX also has options available.
DB2
And VIX itself, the basis for the above, is based on equity options.
Walk me through⌠how reality is different from the theory.
You are contradicting yourself again, and again. The whole thread started with high volatility is a risk⌠you said you can mitigate it by strike selection⌠then you are just throwing word salad.
Absolutely not. There are names where I sell 100, 200 contracts, I can tell you, I am the price taker and not setter. I am not sure how many contracts you are writing, there is no way you are a price setter. Donât confuse you entering a limit order makes you price setter.
Forget about the volatility instruments like derivatives on VIX, even when you are selling an option, the option price is impacted by the volatility. You are essentially selling volatility. You are claiming you can select optimal strike and you are not clear on how volatility impacts your option pricing???
You call that âSelling Volatility.â OK.
To me it says that Volatility drives the price of options which translates to, âPick volatile stocks to sell covered calls for best results.â Said another way, âVolatility is your friend, learn to manage it.â Typically investors are afraid of volatility which also means uncertainty.
Volatility gets on the nerves of investors when they see their portfolio shrink. I get it. To be in business or to be in commission based sales you have to accept volatility. My boss at NCR used to say, âIf you make five calls a day youâll meet your quota.â When I was selling insurance conversations went like this:
Q: âHow did it go today?â
Denny: âGreat.â
Q: âWhat did you sell?â
Denny: âNothing.â
Q: âHow is that great?â
Denny: âIt was my seventh no. Just two more nos to go.â
Itâs a process!
Itâs a âproduct.â I would not touch it with a ten foot pole. Why feed the system?
Cash flow!
When a call is assigned they give you money.
When a put is assigned you have to fork out money which can happen at inconvenient times.
Word salad? Donât you like the home-made dressing? Sorry.
The options of volatile stocks are more expensive compared to the options of less volatile stocks calculated on their normalized stock prices. $100,000 of TSLA stock produces more premium income than $100,000 of NVDA stock.
I would have thought that was obvious.
The Captain
WOW⌠
The Road less traveled was about the person who is not solely focused on getting dopamine hits.
But you have to look at the WHOLE trade. When you do covered calls, FIRST you forked out money to buy the shares, then you sell the call, and then when the call is assigned you deliver those shares.
When you sell the put, you didnât have to give anyone money. Only later, IF the put is assigned ONLY THEN do you have to fork out money.
So with the call, you have to fork over the money FIRST, with the put you only have to fork over the money at the end.
You must not have read my post saying that selling puts is riskier than selling calls. I got the standard reply, 'They have identical risk profiles," which is true. I agreed that they were the same in theory but not in practice. I was asked to explain:
To which I got a most entertaining rejoinder:
Dekightful!
The Captain
I let go with a laugh.. because your understanding and arguments are against basic fundamental tenets. Initially, I thought you were confusing few things, then I realized, you donât understand how options or risk are priced.
On put assignment
Even in the event that you have no cash, and you got assigned, still you can sell the stock that is assigned. Also, letting the put assign shows you have no risk mitigation in place, you should have closed the trade much ahead, when you realized it is not working as you expected. There are other mitigation strategies like, buying a put to convert the naked put to a put spread, or you could roll over the put or you could short the stock for the assignment.
Your statement is typical of many journeymen traders approach. They are scared of accepting any loss, donât actively manage risks, and often substitute prayer as a risk mitigation strategy.
There is one reason why covered call is preferable over naked put, which you have not articulated, is it allows you to manage/ manipulate tax nature of your profit/ loss.
âSoros is the best loss taker Iâve ever seen. He doesnât care whether he wins or loses on a trade. If a trade doesnât work, heâs confident enough about his ability to win on other trades that he can easily walk away from the position. There are a lot of shoes on the shelf; wear only the ones that fit. If youâre extremely confident, taking a loss doesnât bother you.â â Stanley Druckenmiller
I got pretty angry at him when I first figured that out. Because he is giving advice. I never listened, but giving advice is bad.
The Captain
Long before humans invented stock markets they discovered supply and demand as experienced in multitudes of markets. Here is great primer on the subject:
Clear, insightful, and nondogmatic, this book gives us a new appreciation for one of our most ubiquitous institutions.
From the wild swings of the stock market to the online auctions of eBay to the unexpected twists of the worldâs post-Communist economies, markets have suddenly become quite visible. We now have occasion to ask, âWhat makes these institutions work? How important are they? How can we improve them?â
Taking us on a lively tour of a world we once took for granted, John McMillan offers examples ranging from a camel trading fair in India to the $20 million per day Aalsmeer flower market in the Netherlands to the global trade in AIDS drugs. Eschewing ideology, he shows us that markets are neither magical nor immoral. Rather, they are powerful if imperfect tools, the best weâve found for improving our living standards.
Itâs a fun read!
The Captain