Are Covered Calls Worth Doing?
I thought that I would devote this article to answering some of the most frequent questions that I get asked, so it is a bit longer than usual.
But firstly, a look at the market. The big waves died down a lot last week, with 5 small candles and the VIX (Volatility Index) settling down to below 17 after spiking to an intraday high of 24.7 on the 19th August. The charts are not flashing any warning signals right now, but naturally many people are twitchy in the leadup to the twentieth anniversary of the World Trade Center disaster. The question I am being asked a lot is:
Can The Market Continue To Go Up?
I don’t know. Nobody does. I agree that today’s chart looks like it can’t keep going up, but then it has looked like that for several years now! Just for comparison, the chart above shows SPY for the 5 years before the 2000 dot-com crash – it went up 244%. In the last 5 years SPY has gone up 107%.
If you are interested in whether stocks in general are overvalued, I suggest that you look at the August 26 article on the Calafia Beach Pundit. I have mentioned him before. He always gives a great overview of the market and the economy, and I recommend that you read his posts about it. Here’s the link: ScottGrannis.blogspot.com .
Why Not Use Covered Calls?
This is another question that comes up frequently. Given that we are holding deep in the money SPY options, it seems tempting to sell weekly calls against them for income. It is definitely a strategy that gets a lot of coverage, and traders are always looking for a source of income. But is it worth it? Lets have a look.
Writing a covered call is a good strategy if you are in a sideways market. If you are holding a stock that is neither going up nor down, and is not expected to move, then it may work for you. If the stock rises strongly then you will miss out on that profit because by selling the call you have agreed to sell it for a lesser amount.
So, let’s look at the situation wrt SPY.
Let’s say we are holding a SPY 350 Jun 2021 call. It is currently worth $105 (giving us an effective price of $455). Currently, SPY is trading at $453. What should we sell against it? We don’t want to be exercised as we want to keep our SPY option. We hope that the call we have sold expires worthless so that we can just collect the premium – and then do it again next week.
So, at what strike should we sell? If we are looking at 5 days to expiry, it would be very unlikely (although not unprecedented) that SPY would rise by 5% so we will sell 5% above the current price. This means that we could sell the Sep 10,2021 $475 option. Here’s the bid / ask:
In other words, we can sell it for nothing, but why would we do that? Let’s try 4% and sell the $471:
Again, a zero bid. Let’s drop to 3% and sell the $467:
Still a zero bid. How about 2%? We’ll sell the $462:
Finally, we have something we can sell, but for 2 cents? How much would we get for the sale?
Yes, that’s right, $3! So, for our investment of $10,500 we are getting a 0.03% return. Anyone think that this is worth it? Remember that SPY will rise by more than 2% a week several times per year, and we will miss out on those gains.
Now, I do understand that if we do this every week then we would get a bigger return of 1.56% per annum (52 * 0.03%). But given that you would be ensuring that you missed out on any big rises, the question is still is it worth it?
Of course, we could sell monthly options and get a higher premium, but in a month it is likely that SPY would have moved more than 2%. If we sold the $475 (Current price +5%) then we would get $7, or a yearly return of 0.84% (12 * 0.07%).
I encourage you to look at these figures for yourself, and if anyone finds a covered call trade on SPY that works then please email me and let me know!
Death Crosses and Taxes
There have been a couple of reviews on Amazon excoriating me for not including tax strategies into ITM. There is a simple reason: I don’t know much about taxes, and I never trade with taxes in mind. I simply try to maximize my profits safely, and let someone who knows about taxes worry about my taxes. I am not a tax expert.
I find the idea that you wouldn’t make the best profit possible because you were worried about tax rather strange. Would you say no to a salary of $1 million just because you were worried that you would pay too much tax? Of course not. I can’t see anyone in their right mind saying, ‘No thank you, I’d prefer to work for $50K because then I won’t pay so much tax!’
However, everyone’s situation is different and there are many tax experts out there that can help you.
Open Interest and Market Makers
This is a really interesting topic with a lot of questions, but this article is already very long, so I will address that next time.
In The Money: Australian Edition
It was brought to my attention that In The Money: Australian Edition had somehow been replaced by the original In The Money. Not sure how that happened (as the hard copies are all fine) but if you have bought the Australian Edition and it does not have a copyright of 2021 and start with an Australian Introduction then let me give you a replacement one free. Just email me at info@heathercullen.com.
Happy Trading Everyone!
