One of the peculiarities of options is that the parameters are ‘discrete’ numbers. Two are fixed, Strike price and Expiration date. The third, price, is variable driven by the stock price. The result is that comparing options is complicated. My first attempt was to compare the options that could be sold for a given amount of capital. This worked well enough for a small number of options as the list could be eyeballed to pick the best ones to sell. With over 100 stocks to work with the lumpiness of the data makes eyeballing impractical.
Another problem is ITM options. By definition they have a capital loss offset by the higher premium, by the intrinsic value of the option. Initially I tried to work it with the selection process but it proved untenable. Next I improved the selection parameters but that was not god enough
The new approach I’m considering is to analyse each option chain individually to calculate three values, Cash, Dollars per day, and CAGR (instead of the current simple rate). The reason to do it stock by stock is to avoid the influence of the lumpiness of the other stock. The last step in the process is to sort the options by the above results. It should work better but the proof is in the pudding.
In principle the selected options should have high Dollars per day, and CAGR. The Cash is mainly to avoid selling options that don’t much move the needle. One issue I have yet to resolve is how much weight I should assign to capital gain/loss (unknown) vs. option premium (known).
It turned out to be more work than I expected. Initially I selected the options when accessing the database. Coding SQL is hard and calculating CARG with SQL was beyond what I was willing to tackle. This meant a serious rewrite of the Selector’s core function, selecting.
Yesterday I put it to the test. Between the bear market and earning season there are very few options to choose from. The bear market reduced the list by 2/3rds. The earning season reduced the remainder by more than 2/3rds. Maybe it’s time to go to cash.
Not that it’s actionable but here is the first result (this page still needs some work):
One curious thing about the selector are the surprises it generates. It does not quite produce results as expected but seems to have a mind of its own.
For a long time the BMW Method was my favorite TMF board but then it crashed. Jim, the founder of the BMW Method, was not able to go with the flow. The Method worked extremely well until it didn’t. It was a fairly simple way of buying low and selling high with the aid of charts. Jim liked linear charts
When the price hits the bottom green line it was time to buy. When it hits the top green line it was time to sell. Of course, only quality companies were to be traded. Altria, charted above, was one of Jim’s favorites. During the financial crisis banks looked good, hitting the bottom green lines but Jim failed to realize that banks were fragile and didn’t bounce back.
I bring this up because selling covered calls also has its seasons, great during bull runs, dangerous in bear markets. 2023 has been difficult. The method works but on a different set of stocks, instead of on growth stocks, on value stocks, or on growth stocks that hit lows like the BMW Method liked.
A week ago I though I had the problem licked (for the Nth time) but now I’m planning more changes to the Covered Call Selector. The goal is to find above average returns but with a reasonable degree of safety. That lies somewhere between ATM and ITM calls. ITM adds capital protection at the expense of yield. The goal is to find the sweet spot. It’s still a numbers game.
While testing the updated code I noticed that some stocks didn’t yield any calls based the minimum parameters. As I noted earlier, the best calls are on stocks that the market is bullish on, bulls bid up the calls, bears bid up the puts! While sentiment changes over time it changes slowly enough that the Covered Call Selector can be used as a stock screen.
I gave it a try. I uploaded 40 chains from my covered call list. Only 13 passed the grade! That means I can remove two thirds from the list. That’s a big time saver. Not only that, any new addition has to first pass this screening hurdle.
The Captain
PS:
From 135 down to 48. I expect to be adding from some of my other lists. I could not wait to test it vs. my portfolio. Didn’t trade but looking good!
AEHR
AI
AVNT
BEAM
BILL
BRZE
CFLT
COIN
CRSP
CSIQ
DELL
DOCU
DOMO
ENPH
ESTC
FSLY
GH
IONQ
IOT
MRVL
NET
NXT
OKTA
PACB
PATH
PD
PDD
PLTR
PRME
PSTG
RIVN
RNG
ROKU
RPTX
RUN
SDGR
SNAP
TDOC
TMDX
TOST
TWST
U
UPST
VCYT
VERV
WBA
XMTR
Z
Premiums are high when volatility is high but that is not enough to make the stock good for trading covered calls. Over time I made money on UPST but the last trade was a disaster. Bought at $33.36 on September 6 and sold at $23.90 on November 1. The profit on the calls hardly made a dent in the loss.
UPST has been on a downtrend since early August and until that trend reverses, stay away! The chart fooled me in early September, it looked like the trend was reversing.
On November 24 I bought AFRM at $25.718 and sold ATM Dec 15 calls with a strike price of 26. AFRM took off like a rocket! By December 4 it was almost 50% above the strike price. What to do, close the position or let it expire in ten days? The position’s profit is capped by the strike price, it can’t go higher. It’s also very unlikely to drop 50% in 11 days (9 trading days). The benefit is cash in hand sooner which allows trading sooner with more capital.
When an option is deep in the money the Delta is close to 1, the price moves in sync with the stock. The risk is in the bid-ask spreads of the stock but more so of the option. The day starts with very large spreads which shrink as the day progresses provided there is active trading. In other words, to close the position wait until late in the day and best during an uptrend. A narrow spread is important because you want to trade both the stock and the option at the market for quick execution.
If you sell calls on buy and hold positions this is a bad scenario with a huge opportunity loss. If the strategy is trading options instead of investing in stocks, this a perfect outcome. This case illustrates why ‘investors’ should not sell calls on growth stocks.
The Captain
Delta
Delta measures how much an option’s price can be expected to move for every $1 change in the price of the underlying security or index. For example, a Delta of 0.40 means the option’s price will theoretically move $0.40 for every $1 change in the price of the underlying stock or index.
This is definitely a benefit, BUT when you close the position 9 days early, when buying back those options, you are also paying the remaining time premium which looks like something between 25 and 50 cents right now. Is it worth waiting 9 days for an extra 25-50 cents? I suppose it all depends on the next trade. If the next trade, placed Monday, makes you more than 25-50 cents over those 9 days (well, 4 or 5 days by then) then it is definitely worth doing.
The reason for closing the position (option and shares) is improving the odds for the next trade. Selling covered calls is limited by the cash available to trade. The more cash you have the more high priced stocks you can consider. Penny stocks are not likely to be good option candidates. High priced stocks like TSLA are. One TSLA contract requires 100 shares, $23,827 at today’s prices.
One never knows which will be the best options to sell until you run the option chains through the Covered Call Selector. The more data you feed it the better the outcome is likely to be.
In this case I had two options expiring this Friday. Closing the position increased the available cash by almost a quarter (23.5%) at a cost of 0.1443%. If I hadn’t the expiring positions I would not have closed the third option position.
After some baby steps I started trading options, selling both calls and puts, on a more regular basis in December 2010, 13 years ago. It was a long string of lessons, some good, some quite painful. From simple spreadsheets it grew into the Covered Call Selector, part of the larger Portfolio app. The app has gone through several makeovers, the latest in 2016 when it became 100% Object Oriented Programming (OOP). I started work on the Covered Call Selector in 2016. With the latest iterations I think it has reached the limit it can squeeze out of picking Covered Calls. I didn’t post the latest picks because the numbers were so extreme that no one would believe them.
By the end of July I was confident enough to go all in selling covered calls. Now 1/3rd. of the portfolio is TSLA and 2/3rds. covered calls. The problem I now have is that the accounting part of the Portfolio app cannot track the real-time results of option trading. It tracks all the individual transactions but not the outcome of trades, it does not marry capital gains and loses to the premiums collected. That will be my first 2024 project.
To figure out how the covered calls fared this year I had to juggle a bunch of numbers to get an approximation. My best estimate is a yield between 22% and 50%. The largest risk is loss of capital, falling stock prices, bear markets. The selector’s picks are good enough that opportunity loss is not an issue, just don’t sell calls on stocks you want to keep. This means selling calls in or at the money. At the money is ideal but does not protect much against capital loss. In the money has higher premiums and more protection against loss of capital but seriously limits total yield. This is the issue that needs to be addressed each time a trade is initiated.
2024 will be the first full year all in selling covered calls, the real test of fire.
To all Fools, Foes and Friends (FFF), I wish a Merry Xmas and a High Yield Happy New Year!
Buying options is an entirely different proposition.
The Covered Call strategy is predicated on the idea that it works just like casinos do, the sellers are the house while the buyers are the gamblers. Each game in a casino has the odds stacked in favor if the house, the vigorish*. The simplest example is roulette. Winners get 72:1. the wheels have either 73 or 74 pockets, zero and double zero. That makes the odds in favor of the house 73/72 (1.3889%) or 74/72 (2.7778%). The law of large numbers practically guarantees the house makes money provided it protects itself by setting limits on the size of bets.
The premiums on calls are much higher than on casino games but selling calls has the additional risk of large capital loss when stocks tank. Preventing these losses is the difference between really high yields and going broke and the reason to be very selective about which stocks to use for trading calls.
The Captain
*vig·or·ish
noun US informal
[in singular] an excessive rate of interest on a loan, typically one from an illegal moneylender.
the percentage deducted from a gambler’s winnings by the organizers of a game: payment of vigorish to be made at a later time.
I don’t know how things are taxed in Portugal, but have you considered selling puts? The P&L curve is the same as buying a stock and then selling calls. It has one less transaction to pay for. Check out “synthetic covered call”.
Selling puts also works, BUT it isn’t that different than selling covered calls because you need [nearly] as much margin in the account as the capital tied up in purchasing the stock with a covered call.
