Transcript of a long conversation I had with Google AI

[captainccs]

Why not sell ATM covered call options solely by the CAGR of the premium?

GoogleAI

Relying solely on the high CAGR of ATM premiums is a flawed strategy because it ignores the asymmetrical risk profile and opportunity costs of options trading. In strong bull markets, you forfeit all capital gains above the strike, while in severe bear markets, your capped premium fails to protect against the downside. [1, 2, 3, 4, 5]

Selling solely by the projected CAGR of a premium exposes you to several critical pitfalls:

1. The Capped Upside and Asymmetry Trap

• The Mechanism: ATM options provide high upfront premiums because there is a 50% statistical probability the stock will close above the strike price. [1, 2, 3]
• The Consequence: If the underlying asset rallies sharply, you are legally obligated to sell your shares at the strike price. You capture zero upside beyond the strike. Because you still hold 100% of the downside risk but cap your upside, your long-term expected total return often underperforms a simple buy-and-hold index strategy. [1, 2, 3]

2. Illusory Downside Protection

• The Problem: While the premium offers a small buffer, it does not prevent the underlying shares from plummeting. If an underlying stock drops 30% and your premium was 3%, your net position is still down 27%. In a severe crash, you suffer near-full downside with limited ability to recover. [1, 2, 3, 4]

3. The Reinvestment and “Assignment” Cycle

• The Problem: Consistently selling ATM calls means your shares will frequently be “called away” (assigned) during any upward price movement. This forces you to either buy back the stock at a higher price or continuously find new, equivalent underlying equities, incurring extra transaction costs and potential capital gains taxes. [1, 2, 3, 4]

4. High Tax Burdens

• The Problem: Option premiums are frequently taxed as short-term capital gains or ordinary income, reducing the net yield significantly depending on your jurisdiction. To mitigate this, investors using covered calls on platforms like Interactive Brokers or DeGiro often utilize tax-sheltered accounts. [1, 2, 3]

5. Ignoring Fundamental Analysis

• The Problem: Chasing the highest premium often forces you to sell calls on highly volatile, speculative stocks. If the stock’s fundamental value deteriorates, the high premium is treated as “chasing yield,” leaving you holding depreciating shares. [1]

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Why not sell ATM covered call options based on the CAGR of the premium?

GoogleAI

Selling ATM covered calls purely based on premium CAGR (Compound Annual Growth Rate) overlooks opportunity costs and asymmetric risk. This single-minded focus mathematically locks in your maximum potential profit, severely underperforming in bull markets while offering negligible protection during significant downturns. [1]

1. The Trap of Capped Upside

The biggest risk of selling At-The-Money (ATM) calls is opportunity cost. An ATM call option usually has a delta of roughly 0.50, meaning it guarantees your stock will be called away if the market rises even moderately. [1, 2, 3]

• You collect the premium, but you completely miss out on major bull runs in high-growth equities. [1]
• You end up trading the compounding power of the broader market (or individual stocks) for a fixed, immediate income stream that historical data shows often underperforms a simple “buy and hold” strategy over the long run. [1, 2, 3]

2. Illusory Downside Protection

While the premium collected from an ATM strike is high, it offers limited downside protection. If the underlying stock drops significantly, the premium will not be enough to cover the loss on your shares. You are then stuck holding a declining asset or forced to sell it at a substantial loss. [1, 2, 3, 5]

3. Tax Consequences of Forced Assignment

When a stock is called away, it is treated as a taxable event. If you repeatedly sell ATM calls on your core portfolio: [1]

• You trigger frequent short-term capital gains taxes (or local equivalent taxes based on your jurisdiction).
• This constant tax drag substantially reduces your net, after-tax CAGR, making it extremely difficult to beat a buy-and-hold index strategy.

4. The Illusion of CAGR

Attempting to annualize the premium of a short-term (e.g., 30-day) ATM call to project a massive CAGR is a common pitfall. This projection relies on the faulty assumption that the exact same premium can be collected week after week or month after month indefinitely. In reality, being assigned means your capital is likely moved to cash, or you are forced to buy the stock back at a higher price, breaking the cycle of continuous premium collection. [1, 2, 3]

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Why not sell ATM covered call options based on the CAGR of the premium and rolling up and out if ITM near expiration?

GoogleAI

Selling ATM covered calls targets maximum upfront premium, but rolling an ITM call up and out locks in realized capital losses on the underlying stock and increases your breakeven point. This cycle ultimately locks you into a losing position or caps your long-term upside. [1, 2, 3, 4, 5]

1. The Trap of Rolling “Up and Out”

When you sell at-the-money (ATM) and the stock rises, the call goes in-the-money (ITM). To “roll up and out,” you must buy back the ITM call at a loss and sell a higher-strike call with a later expiration. [1, 2, 3, 4]

• Capital Loss: Buying back the ITM call requires paying the intrinsic value (the difference between the stock price and your strike). [1]
• Locked-In Loss: Because the option’s cost exceeds the premium you collect from rolling to a higher, further-out strike, you end up realizing a net loss on the options trade. [1, 2]
• The Breakeven Spiral: Your cost basis increases, meaning the stock has to rise higher just for you to break even on the underlying shares. [1]

2. Capped Upside, Full Downside

While ATM premiums look great on a compound annual growth rate (CAGR) basis, this ignores the asymmetry of the trade. You give up all capital appreciation beyond the strike price, but you still bear the full downside risk if the stock plummets. Chasing the highest CAGR in premiums often means picking highly volatile stocks, exposing you to significant capital loss while strictly limiting your potential gains. [1, 2, 3, 4]

3. Suboptimal Extrinsic Value

Because you are selling ATM, you are relying entirely on the “time premium” (extrinsic value) to capture income. However, the decay accelerates only as the option gets closer to expiration. At ATM, if the stock makes a sudden directional move, the call immediately goes deep ITM, leaving you with little time value to offset the losses on the underlying asset. [1, 2, 3]

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Why not sell OTM covered call options based on the CAGR of the premium and rolling up and out if ITM near expiration?

GoogleAI

Selling out-of-the-money (OTM) covered calls while rolling up and out is a popular strategy, but it significantly underperforms a buy-and-hold approach in bull markets and carries hidden risks that erode long-term returns. [1]

Here is why this strategy often fails to deliver the promised CAGR:

• Capped Upside vs. Uncapped Downside: You absorb the full downside of the underlying stock but cap your gains at the strike price. In a strong bull market, your stock gets called away, forcing you to miss out on major rallies. [1, 2, 3, 4]
• The “Rolling Tax”: When the stock goes deep in-the-money (ITM), rolling up and out requires buying back the short call at a loss and selling a new one further out in time. This continuously locks in realized losses and frequently pushes your breakeven point higher. [1]
• Capital Destruction in Bear Markets: If the stock crashes, the OTM premium collected offers minimal downside protection. Your premium income is quickly dwarfed by the loss in the underlying asset’s value. [1, 2]
• Opportunity Cost of Volatility: This strategy thrives in stagnant or slowly rising markets. However, the premium collected often fails to compensate for the lost compounding effect of reinvesting dividends and capturing upward price shocks. [1]

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What covered call options strategy would you recommend?

GoogleAI

I recommend the 30-45 Days to Expiration (DTE) and 25-30 Delta Strategy using the Investopedia Covered Call Guide for reliable, consistent premium income. Sell a call option with a strike price roughly 5-10% higher than your purchase price to pocket upfront cash while still allowing for modest capital gains. [1, 2, 3, 4, 5]

A quick visual breakdown of the traditional covered call structure:

Strategy Aspect	Recommendation	Why This Works
Duration	30 to 45 Days	This timeframe captures the “sweet spot” for accelerated time decay, allowing you to maximize premiums without locking up your shares for too long.
Strike Price	25 - 30 Delta	Offers the best balance of probability and return, keeping your strike Out-of-The-Money (OTM) so you still capture slight stock appreciation.
Asset Choice	High-Quality, Stable Holdings	Never pick a stock just to sell covered calls. Only sell calls against 100 shares of underlying assets you’re comfortable holding long-term.

Actionable Tactics & Management

1. Entering the Trade

• Buy-Write: If you don’t own the asset yet, you can buy the 100 shares and sell the call in a single, simultaneous transaction. [1, 2]
• Avoid Earnings: Do not sell covered calls during the week of the stock’s earnings report to protect yourself against wild, unexpected price swings. [1, 2]

2. When the Trade Goes Wrong

• Rolling Down: If the stock’s value decreases, “roll down” the call option (buy back the current short call and sell a lower strike call) to collect additional premium and lower your overall cost basis. [1, 2]
• Acceptance: Understand that covered calls cap your upside but do not protect you from a severe plunge in the stock’s underlying price. [1, 2]

3. When the Trade Goes Right

• Rolling Up & Out: If the stock shoots up past your strike price, close your option and simultaneously sell a new one at a higher strike price and later expiration date (for a “net credit”) to prevent your shares from being called away. [1, 2]

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Conclusion

I’m doing pretty much what GoogleAI recommends!

The Captain

[albaby1]

@captainccs

I’m doing pretty much what GoogleAI recommends!

I mean…not really. You asked it twice if selling covered call options in general was a good idea, and it told you they would underperform. You then started asking it about specific covered call strategies, and it told you they would underperform. You then asked it what covered call strategies it would recommend, and it gave you one - because that’s what you asked it to do. If you tell GoogleAI to recommend something to you, it will recommend something to you (whether it’s a good idea or not) - but when you asked it whether any of these approaches were a good idea, it told you “no.” Repeatedly, and for the same reason that we discussed in the other thread: selling covered calls means you’re assuming a lot of downside risk by having to take a long position in a volatile stock.

In short, GoogleAI is basically telling you not to sell covered call options. So you’re not doing what GoogleAI recommends.

I asked GoogleAI the following question:

Am I likely to outperform the market if I sell covered call options?

Its response was:

No, you are historically unlikely to outperform the broader market. While covered calls generate upfront premium income, they inherently cap your upside gains and leave you fully exposed to downside losses. Consequently, they tend to underperform buy-and-hold index strategies during strong bull markets. [1, 2, 3, 4]

Covered calls are not designed for market-beating total returns. Instead, their true purpose is to trade potential upside for immediate cash flow and moderate downside risk. [1, 2, 3]

I mean, if you’re going to listen to GoogleAI for investment advice…

[captainccs]

@albaby1

Am I likely to outperform the market if I sell covered call options?

You seem to think that option trading is just one immutable thing. It isn’t. I recommend you read

Option Volatility and Pricing: Advanced Trading Strategies and Techniques, 2nd...

Not just read, study, and learn.

What does “Advanced Trading Strategies and Techniques” mean? That there is not just one outcome from option trading, that you can bend the market in subtle ways.

One of the interesting things in GoogleAI’s replies to my questions is that they contradict each other. Why? Suppose someone learns the basics, just the mechanics of option trading, what conclusion does this someone reach? “No, you are historically unlikely to outperform the broader market.” Why? A Pareto Distribution would emerge. 20% will outperform and 80% will underperform. How do you move into the 20%? By eliminating the negatives.

As I was taking my walk yesterday I was thinking about starting a new options thread but it got too complicated so I used the AI transcript alternative.

My first though was, “If you sell a naked call…” That’s fraud! You can’t sell what you don’t have or own. An option is not a thing you sell, it’s a contract giving one party the right to buy (call) or sell (put) a number of shares at a set price for a length of time (American options). Why is this important? Because the expert cannot presume about whether you do or do not own the shares. The expert opinion excludes any potential prior trades thereby presuming naked options.

Let’s pause here for a minute. What would an options expert say about writing the call contract? “You are giving up a lot of potential upside and taking on an unlimited risk on the downside should the stock skyrocket.”

What to do? How about buying the shares ahead of time which then is called “a covered call.” That does not solve the potential upside gain issue but it does limit the downside to the money paid for the stock should the call be ITM and assigned. That’s one way to reduce the risk, one way to improve the odds of making money.

What about the loss of the potential upside should the call be ITM at expiration? How about rolling the call up and out? That’s a SECOND way to reduce the risk, another way to improve the odds of making money.

What if the cost of rolling up and out is too high? Let the call expire and take your smaller profits. This is not a real loss, it’s an opportunity loss. Something to take into account when initiating the trade. Some critics comment that buying back the same shares is losing money. Money doesn’t care what you buy, if one stock is no longer attractive look for another that is. Or wait for this one drop back down, volatility is a two way street.

I’ll stop here because the above explains why AI is “apparently” contradicting itself. When you ask a generic question the reply has to be about how the simple trade works, “No, you are historically unlikely to outperform the broader market.” As you hedge your bets, as you start using Advanced Trading Strategies and Techniques, the odds start to change in your favor. They are never risk free but the odds improve as happens in BlackJack with card counters.

Well, one more thing. Option chains have from hundreds to thousands of options making it impossible to pick the best ones by eyeballing the chain which is why I created the Covered Call Selector and the Covered Call Roll Selector. Both improve the odds of making a profit.

It’s all about improving the odds.

The Captain

PS: Do read “Advanced Trading Strategies and Techniques” by Sheldon Natenberg to improve your odds of making money when trading options.

[albaby1]

@captainccs

You seem to think that option trading is just one immutable thing.

I don’t. I’m simply pointing out to you that GoogleAI isn’t recommending that you trade covered calls, as you suggested in your post upthread.

It’s clear that you have invested a lot of time and mental energy into working with covered call option systems. And from your posts, it sounds like you believe that investing using that type of system - as opposed to just going long in stocks - offers some structural advantage versus your counterparties. But it just doesn’t. Layering in more complexity by adding in features like rolling your options doesn’t change that. And asking GoogleAI to tell you otherwise is just a fool’s errand

Covered calls don’t really give you any edge in the market. It’s certainly true that like most investing strategy (including just buying stocks!), you can make money in the market using this system if you have genuine stock-picking ability. IOW, if you have the ability to genuinely and repeatedly identify mispriced securities or derivatives where the market price does not accurately reflect what’s going to happen to the security or derivative, you can make money. If you have real alpha, you can pick the stocks that will beat the market or the options contracts that will let you outperform selling covered calls.

Do your Covered Call Selector and Covered Call Roll Selector give you that genuine alpha? I mean, it’s possible. The odds are a little long, because you’re in the same market - the same casino - as all the major quant shops like Jane Street that have invested untold resources in setting up their own algorithms for identifying mispriced option contracts. They’ve invested in high-speed feeds, hiring countless applied mathematics Ph.D’s, and high-end computer hardware that allow them to identify mispriced options the very instant they appear and then trade that edge down to zero. That’s why quoted options prices trade so close to the “correct” B-S- prices. It’s theoretically possible that you’ve built a better mousetrap than these professional shops - but that’s a rough proposition.

As we discussed in the other thread, employing this approach doesn’t make you “the house” in an analogy to a casino. These systems don’t give you any structural edge over your counterparties. Instead, you’re placing bets within the casino sportsbook - you’re in the same structural position as any of the other bettors. Except in this analogy, you’re sitting in the same sportsbook as other people who have more knowledge about everything about the sporting events than you have the time or resources to accumulate, access to faster and better information, have vast pools of capital to deploy, and have invested hundreds of millions in constructing computer hardware and software to analyze every single bet permutation within milliseconds, 24 hours a day, to trade away any mispriced bets that result from any amateurs in the sports book.

Again, there’s no theoretical reason that you can’t have discovered a system that lets you take your small capital pool and outplay those guys. It’s not impossible that armed with a few investment books and a home-cooked app that you can find those mispriced options before the big guys flood them with capital that’s properly hedged with dynamic hedging (rather than just covering the call, which doesn’t hedge the risk the way you think it does). But consider the odds.

[captainccs]

@albaby1

GoogleAI isn’t recommending that you trade covered calls, as you suggested in your post upthread.

You have a reading/understanding issue. More jet lag?

@albaby1

And from your posts, it sounds like you believe that investing using that type of system - as opposed to just going long in stocks - offers some structural advantage versus your counterparties.

If by counterparties you mean the call buyers, most certainly. The rest of the world, who cares?

@albaby1

Layering in more complexity by adding in features like rolling your options doesn’t change that.

It’s not “layering in” (whatever that means) buy an integral part of the strategy.

@albaby1

And asking GoogleAI to tell you otherwise is just a fool’s errand

i didn’t ask for advice, i already have my system! I was testing GoogleAI. You keep making up things! Jet lag?

@albaby1

Covered calls don’t really give you any edge in the market.

That’s your opinion, Document it! An edge in the market does not pay my bills. It’s irrelevant

@albaby1

Do your Covered Call Selector and Covered Call Roll Selector give you that genuine alpha?

What is genuine alpha?

GoogleAI:

In investing, genuine alpha is the excess return an investment produces compared to a benchmark index (like the S&P 500), specifically after adjusting for the risk taken. Unlike beta (returns simply earned by riding overall market trends), genuine alpha is a measure of an active manager’s true skill or “edge” in identifying pricing inefficiencies.

I haven’t got the faintest idea, I’m not in a race with anybody. Irrelevant question. You keep adding irrelevancies.

@albaby1

As we discussed in the other thread, employing this approach doesn’t make you “the house” in an analogy to a casino.

That’s your opinion and you are welcome to it. Makes no difference to me. More irrelevancies.

@albaby1

Again, there’s no theoretical reason that you can’t have discovered a system that lets you take your small capital pool and outplay those guys.

I’m not playing against anybody, I’m funding my lifestyle. Yet more irrelevancies.

My reason for posting is because I find the system useful enough to share with fellow Fools.

The Captain

[albaby1]

@captainccs

My reason for posting is because I find the system useful enough to share with fellow Fools.

And my reason for responding is to point out to fellow Fools that this is a system that will likely underperform the market, and therefore shouldn’t be implemented unless you have a specific reason to exchange market underperformance for income flows.

If you don’t have genuine alpha in picking call options that are mispriced, then this is a foolish (small “f”) system to employ. You - and anyone else - would be better off just taking that capital and putting it in a broad market index fund if you’re seeking to “pay your bills” by investing. And if you did have that genuine alpha, there’s far more profitable ways to exploit it than this system (as DrBob pointed out in the other thread).

The fact that you don’t seem to understand why you don’t have a structural advantage over your counterparties (they experience time decay, but you experience asymmetric risk, and those two things counterbalance each other) should make you question whether you have any genuine alpha through your system. The things that you dismiss as “irrelevancies” are actually quite relevant to why your system doesn’t give you the structural advantage you think it does, and should give you pause about continuing it.

If you have a specific need to trade overall performance in exchange for near-term cash-flows, then covered calls are one way to do that. It’s not the most efficient way, but it’s one way. But as an investment strategy, it only looks like it would be useful because people tend to underestimate the degree to which the downside risk in the long-side equity holdings drags down the overall performance.

[albaby1]

@captainccs

Not just read, study, and learn.

BTW, since you seem to esteem Natenberg’s views (and AI responses), I asked AI to summarize from his writings and public statements about whether one can use covered call strategies to outperform the market. The response:

The short answer is no. Based on his writing and public teaching, Sheldon Natenberg would not say that a retail trader can simply use covered calls to reliably outperform the market.

Natenberg’s central philosophy in Option Volatility & Pricing is that:

• Options are fairly priced most of the time in competitive markets.
• A trader’s edge comes from having a better estimate of future volatility than the market, not from using a particular options strategy.
• Covered calls, cash-secured puts, protective puts, etc., are simply different ways of packaging exposures to delta, theta, gamma, and vega.

In fact, Natenberg spends considerable effort explaining that a covered call is not a magical income strategy. It is equivalent (via put-call parity) to a short put plus cash. If you wouldn’t expect selling naked puts to automatically beat the market, you shouldn’t expect covered calls to either.

His framework is essentially:

A covered call is long stock + short call.

The stock provides most of the expected return. The short call:

• earns option premium (positive theta),
• but gives up upside,
• and creates short volatility exposure.

Whether this improves returns depends largely on whether the option was overpriced relative to realized volatility—not because it is a covered call.

What would he likely say about retail traders?

Natenberg would probably argue:

• No persistent edge comes from merely selling covered calls.
• If retail investors systematically earn excess returns selling calls, it must be because they possess an informational or volatility edge.
• Most retail traders do not have such an edge.

This is very consistent with how professional options market makers think.

Would he deny that covered calls sometimes outperform?

No.

He would readily acknowledge that:

• in flat markets,
• in mildly bearish markets,
• or when implied volatility is unusually rich relative to realized volatility,

covered calls can outperform simply holding the stock.

But he would view that as a consequence of market conditions—not because covered calls are inherently superior.

I know - TL;DR. Here’s the takeaway - Natenberg believes, like almost everyone in the field, that options markets are very efficient and that options are fairly priced. Because options are fairly priced, you don’t get any kind of structural advantage by being on either side of the option - or by using any more complicated options trading strategies. All you do is re-package your exposure to the different aspects of risk inherent in the derivative.

[rainphakir]

@albaby1

, I asked AI to summarize from his writings and public statements about whether one can use covered call strategies to outperform the market.

I do NOT sell covered calls to out perform the market.

I sell covered calls (CC) in order to get disposable INCOME that pays for some “want”.
It’s an income strategy.
And it’s short term.
So far this year CC have paid for some travel.

If the goal of an investment is to out perform the market … I use a LTBH (capital gains) strategy.
The L = long term.

Denny says:

@captainccs

I’m funding my lifestyle.

The $s he’s using in his CC strategy are NOT intended to out perform the market.
They are the “tools” by which he gains income that funds his lifestyle.

Selling options is appropriate for gaining disposable income.

It is NOT appropriate for out performing the market.
This is the answer you got from AI.

More specific inputs to the AI would generate more complete answers.

In the prompt, tell the AI:

• the goal of the investment
• the time frame
• the risk tolerance
• other pertinent info
• tell the AI to ask you questions to verify that it’s output will meet your goals.

Then ask the AI if a particular strategy is likely to fulfill that objective.

ralph

[McLovin1981]

@captainccs

I haven’t got the faintest idea, I’m not in a race with anybody. Irrelevant question. You keep adding irrelevancies.

I don’t have a dog in this fight, but it is completely relevant. In fact, it is central to the whole discussion. If you are not generating genuine alpha, then your entire strategy is pointless.

[albaby1]

@rainphakir

The $s he’s using in his CC strategy are NOT intended to out perform the market.
They are the “tools” by which he gains income that funds his lifestyle.

I mean - is that right? In the other thread he was talking about having a mechanism for choosing the correct stocks for writing calls, and how there were structural advantages to this strategy. That strategy, as described, involved putting cash into the market (opening long positions) and while selling calls on them. That’s a buy-write strategy, not trying to convert existing long positions into disposable cash. If you already have the disposable cash in hand, you wouldn’t do that to gain disposable cash - you would just refrain from opening a new position. It sure sounds like he believed that CC strategies were intended to be an investment strategy (because he falsely believed there was some genuine advantage inherent in selling calls), not a means of getting cash out of an existing portfolio.

@rainphakir

Selling options is appropriate for gaining disposable income.

Why would you do that? If you need $X from your existing portfolio, then why not just sell $X of stock? The transaction costs are lower, the tax consequences are slightly better (assuming a taxable account), and it’s less risky.

[captainccs]

@albaby1

BTW, since you seem to esteem Natenberg’s views (and AI responses), I asked AI to summarize from his writings and public statements about whether one can use covered call strategies to outperform the market. The response:

I don’t esteem his views, I esteem his teachings which allow one to come up with better option strategies. All that AI came up with about Natenberg’s views are news to me.
Beating the market might have been my goal 25 years ago and I did pretty good until I didn’t. At 87 my main investing objective is to finance my lifestyle. Ask Google about that.

@McLovin1981

If you are not generating genuine alpha, then your entire strategy is pointless.

Edit:

i just reread the definition of Real Alpha

In investing, alpha measures an investment strategy’s ability to beat the market or generate excess returns independent of overall market movements. “Real alpha” refers to verified, risk-adjusted outperformance driven by genuine skill, rather than just luck, hidden risks, or broad market trends.

No way will I ever calculate that. A buck is a buck and math does not pay the bills. How do you calculate hidden risks. How do I know if my options strategy is genuine skill or luck? My answer to that is that the strategy mimics casino gambling with the odds favoring the house. If true it is a tried and tested money maker.

End edit.

@albaby1

That strategy, as described, involved putting cash into the market (opening long positions) and while selling calls on them

Another misunderstanding. At 87 I don’t have gainful employment to add to the portfolio only excess cash from option premiums after living expenses.

@albaby1

Why would you do that? If you need $X from your existing portfolio, then why not just sell $X of stock?

Why do you prefer depleting your portfolio?

These last two are funny, first you add to my port then to take from the port.

The Captain

[albaby1]

@captainccs

I don’t esteem his views, I esteem his teachings which allow one to come up with better option strategies.

But his teachings don’t allow one to come up with better option strategies. His teachings are that modern options markets are incredibly efficient, that options are fairly priced, and that therefore you can’t systematically gain excess returns selling calls unless you have an informational or volatility edge. IOW, unless you have genuine alpha (the ability to know which options are mispriced) your options strategy, no matter how convoluted, cannot get you excess returns.

@captainccs

Why do you prefer depleting your portfolio?

Because you deplete it less if you just sell the stocks, rather than engaging in a covered call strategy. As noted above, generally speaking selling covered calls will underperform the market. You’ll get less in premiums than your lost appreciation in the underlying equities. If you want to generate income equal to (made up number) 2% of the value of your portfolio in a given year, you’ll likely end up with a bigger portfolio just selling 2% of the portfolio than selling covered calls to get that 2% in the form of premiums.

Plus, options generally have higher transaction costs (commissions and the market makers take a higher vig through significantly higher bid-ask spreads). If you’re in a taxable account, the tax consequences are generally worse also.

So if you want to generate cash from their equity portfolio, you’ll generally be better off just selling the X% of the portfolio to create that cash than trying to construct it from selling options, once you take into account the reduced appreciation that your portfolio suffers.

[mostlylong]

@McLovin1981

If you are not generating genuine alpha, then your entire strategy is pointless.

I know that you know all of this, but for the sake of clarity of defining terms:

Benchmarks matter.

Alpha depends on choice of benchmark.

In the long run, 100% stocks is the best allocation (for return) because increasing time horizon to the “long run” averages over fluctuations in markets (risk).

But not every time horizon is “long run.”

A shorter time horizon might dictate a different asset allocation, such as more bonds relative to stocks. And hence a different benchmark.

Still, as this and other threads show, buy-write will only outperform pure long stocks for flat-ish markets (for calls sold relatively near the current stock price).

As I mentioned in the other thread, buy-write is materially more risky on single stock versus index underlyings (just as being outright long single stock vs index).

Thus, as others wrote, if you are good at individual stock selection, then (perhaps) it might make sense to just be long the stock.

But just being long, for example, Tesla, might not be such a great strategy because the stock hasn’t really gone anywhere in years and thus not a great stock for outright long and selling shares for income periodically unless you can time the ups and downs (to that I say: prove it by showing trades as they are opened).

Tesla is very volatile, but, on average, hasn’t gone anywhere but sideways since it ran up in about 2021.

So Tesla might be ok for selling calls, but it’s a wild stock, so I would again say prove it by showing the trades.

We’ve never seen the specific trades.

We’ve only heard tales that don’t make sense to most here.

I was trying to think of a benchmark for buy-write.

Spitballing, I thought about high-yield bonds and convertibles (maybe not converts after 30 sec of more thought, lol), which are assets that live at the boundary between equity and debt in the capital structure.

[rainphakir]

@albaby1

Why would you do that? If you need $X from your existing portfolio, then why not just sell $X of stock?

Remember this comment?

@rainphakir

• the goal of the investment
• the time frame
• the risk tolerance

Your question is answered by
"What is the goal of this investment?

Answer: I want INCOME.

At the end of the trade, I STILL HAVE ALL the shares I bought.
And, I got the income I wanted and paid the “bill” for whatever I wanted.

Let me say that this way… I still have the tools that I started with.
And I got some income along the way.

“What is the time frame of this trade?”
At expiry, the option trade closes.
If I bought shares, then I make the next decision/s:
Another CC?

Sell the shares n choose a different stock?

Convert the shares that I bought for the CC to … LTBH?

I’ve done all three.

Risk tolerance. I’m pretty tolerant.

Alpha.
I get net gain in income selling AN (one trade) option (and I still have the tools I used to get that gain). Am I doing “alpha” right?

Personally I don’t pay any attention to alpha.

@albaby1

I mean - is that right? In the other thread he was talking about having a mechanism for choosing the correct stocks for writing calls, and how there were structural advantages to this strategy. That strategy, as described, involved putting cash into the market (opening long positions) and while selling calls on them.

Please spend some time to understand the concept of COVERED in Covered Calls.

(And CASH SECURED in Cash Secured Puts.)

It has to do with limiting the “risks” of an options trade that goes against the trader.

ralph

[McLovin1981]

@captainccs

I didn’t say I was not generating genuine alpha. I said I had no idea whether or not I was generating genuine alpha

You also said it was “irrelevant.” But it is relevant because if you aren’t (relative to the appropriate benchmark of course), then your strategy is worse than the alternative. Or best case, the same.

[captainccs]

@albaby1

In the other thread he was talking about having a mechanism for choosing the correct stocks for writing calls,

Not the correct stocks, the best stocks from a preselected list. This is the quote.

@captainccs

I have stated the mechanism by which covered calls make money and that includes picking the right stocks.

1. Stocks that don’t go broke
2. Volatile stocks that bounce back
3. Stocks whose call options produce the highest returns

First you have to find/guess “Stocks that don’t go broke” and “Volatile stocks that bounce back.” Using the found list of stocks the Covered Call Selector ranks “Stocks whose call options produce the highest returns” which considers both premium and capital gains/loses.

The Captain

[mostlylong]

@albaby1

I mean - is that right?

I fear we will never understand covered calls.

Let’s try short puts.

Someone explain.

[captainccs]

@McLovin1981

You also said it was “irrelevant.” But it is relevant because if you aren’t (relative to the appropriate benchmark of course), then your strategy is worse than the alternative. Or best case, the same.

What is the alternative strategy? Traditional investing for capital gains? That doesn’t generate cash income which is my objective. My ideal situation is generating enough income to cover my living expenses without having to sell shares. Better yet, even more cash to buy more shares. If the volatile stocks bounce back as expected Alpha is protected. This was the initial motivation.

Seeing the good results during some five years I started wondering if covered calls might not be better than traditional stock picking strategies. The importance of the likeness to the casino model is that it dispels the notion that it’s just a freak. If the volatile stocks truly bounce back then real alpha is generated, provided, of course, that one avoids getting calls assigned. Practice says that it can be avoided except when stocks skyrocket and the negative premium is too high to roll up and out. This is the major risk. What I learned during the latest steep downdraft is to be more careful rolling down and out. It’s safer to collect less income while maintaining a higher strike price (protecting alpha).

The Captain

[albaby1]

@rainphakir

At the end of the trade, I STILL HAVE ALL the shares I bought.
And, I got the income I wanted and paid the “bill” for whatever I wanted.

Well, no. I mean, that’s only true if your shares don’t get called away. Which is a non-trivial outcome in this trade.

So this isn’t really a great thing. You only still have all the shares you bought if the shares didn’t perform well. You get to keep them if they went down in value, or only went up a bit. But if those circumstances where they went up a lot - well, then you lost them. The option was exercised and they were acquired by your counterparty.

That only happens a portion of the time, but that’s the whole point of the trade - it happens enough that the option buyer gets value out of the transaction.

@rainphakir

I get net gain in income selling AN (one trade) option (and I still have the tools I used to get that gain). Am I doing “alpha” right?

No. You don’t get to keep all the tools you used if the option ends up ITM. If that happens, the shares get called away. The premium you get is based on how likely that is to happen - higher volatility corresponds to a higher premium and to a higher probability that a random walk of the stock price will lead it ITM.

The “price” you pay with covered calls includes the asymmetric assumption of risk in the underlying shares. You own all of the losses if they decline in value, while your counterparty owns all of the upside (or most of it, anyway) if they appreciate in value.

Generally, options markets are fairly efficient. Unless you have the ability to identify options that are mispriced (which is what “alpha” refers to), those losses in your equity positions while you keep your calls covered will eat up your premiums by enough that you’re underperforming general equity performance. You’d be better off just selling the small portion of the shares, so you can have more value in your portfolio in the timelines where the share prices rise.

@captainccs

Not the correct stocks, the best stocks from a preselected list.

Which list you preselected for what purpose? To be the right stocks to serve as the basis for covered call options, right? And the “best” stocks from that preselected list are the ones that are the correct ones to be used for covered calls, right? This is just quibbling - you’re suggesting that your “Covered Call Selector” has given you the ability to find stocks whose covered call options are fundamentally mispriced, because these stocks won’t actually experience deep declines (or will bounce back).

Which - maybe? Options markets are really efficient, with a lot of resources (massive supercomputers, super-fast speeds, tons of applied maths PhD boffins) trying to find every such mispricing and deploying enough capital to trade them away within milliseconds. Maybe your homegrown app that you check periodically is going to find mispriced signals before they get traded away by the quant shops. But if so, that would be the reason this strategy works - not because there’s any structural advantage to writing covered calls.

[rainphakir]

@albaby1

No. You don’t get to keep all the tools you used if the option ends up ITM. If that happens, the shares get called away.

It is true that the shares might get called away.

At the strike.
And, I have, on occasion, allowed that outcome.
I got the $ I spent for the shares, plus any intrinsic value I negotiate by selling a strike slightly above my buy point.
I also pocketed the premium.

The “tools” are the $s I used to buy the original shares. Ie, not the shares.

I still have those tools.

I don’t (rarely) sell ATM strikes.
The strike I choose depends …
On my goal for that trade.
(Remember that comment - from above?
Let me rephrase it: “plan the trade n trade the plan”.)

My chosen strike is usually slightly OTM.

@albaby1

You own all of the losses if they decline in value,

If I buy shares and they decline, I own the loss…
EVERYONE who buys shares of stock accepts this “risk”.

If I sell CC on those shares, my loss declines.
I’ve experienced this.
A couple times, I’ve CCd slightly ITM, the stock declined to OTM, I rolled down to slightly ITM, … Repeat.
The premiums wound up keeping pace with the price decline.
It was really quite remarkable.

More common, I’ve owned shares whose price was deep underwater.
In this case, I wrote CC further OTM, lower probability of being exercisd. Sometimes they got called away. But other times, the price would recover and I CC’d it back up.
These were/are stocks I’m happy to own anyway.

I easily tolerate the risk.

@albaby1

while your counterparty owns all of the upside (or most of it, anyway) if they appreciate in value.

I don’t care.
My primary goal is income, not the putative upside.
I want the premium for use as disposable income.
And I want my original “tools” returned to me, so that I can use em again.

I do NOT care if I miss some upside.
My goal is elsewhere.

The premium is IN MY HAND AS SOON AS THE TRADE OPENS.
I spend it. Cause that’s why I opened the trade.

Then I wait for the expiry to approach.

Caveat. The trade can run away, either up or down.
That’s why when I open the trade, I already have a plan for how I’m gonna manage it.

I don’t fall in love with my stocks. They don’t/won’t love me back.
If the shares get called away, oh well. I’m already ahead… I’ve met my goal.

While I’m selling options, I’m getting income… And I’m NOT selling shares out of my LTBH portfolio.

I’m not selling my LTBH port down.
I’m not selling any LTBH assets.
It’s continuing to grow.

At some point I expect I’ll not be able to do options. Or trade individual stocks.
At that point, I plan to switch to the 4% SWR strategy.

Let me add… The percentage of my total port, that I use for selling options, is small enough that, if it goes completely to zero… My lifestyle will not be severely affected.
This helps my risk tolerance.

ralph

Let me revisit this claim:

@albaby1

your counterparty owns all of the upside (or most of it, anyway) if they appreciate in value.

I bought HUT at $40 as a wheel strategy, CC options trade.
I CC’d it, weekly expiries, rolling up n out… I was getting the upside.

I rolled til it got to 60ish, when HUT ran away… Gapped Up. I was at risk of having the shares called away.
I switched to monthly expiries n then to 9 month expiry n rolled up to 75. For 18$ premium.
I’m now waiting… And 45 days before expiry, I’m gonna roll up 1 more time. To 80 or perhaps 90.
That’ll be a solid 100% intrinsic gain … NOT including the premiums.

So, you see? I DO have the ability to capture a significant part of the upside.
And… If the shares get called at the next expiry or a later expiry.. it’s long term capital gains tax rate.

It IS possible that HUT might drop…
But so far things are looking good.
IMO.

ralph

Did you see this

Selling options raises me up a level.