in today’s world, cash has a negative return which drags on the return of your put write strategy. in my experience, changes in interest rates over the past 10 years have had almost no effect on option premiums. apple may not be the best example but if you can buy a stock with a 3-4% dividend yield, you’re already almost 3-4% better than holding cash alone. why sell an option with an annual premium of say 4% and collect 0% in interest on your cash when you can receive a 4% dividend, probably 3-4% more if you wish to sell covered calls. in theory selling puts to buy at a lower price with cash may make sense, but in practice it’s never made sense to me, BUT i could imagine it making sense if the cash yield was higher than the average dividend yield.
This isn’t a terrible strategy at all. However…
I know I’ve looked at alot of stocks that I’d consider buying 10-20% cheaper than they are now, but the problem with most of them, is that if they hit that 20% cheaper, then something bad has probably occured. Technically it starts to look early to invest and fundamentally something might have broken down too.
Still, not a bad idea to take the premium if you’d just like to buy something at the bottom of a range.
you have a 4% annual return cuz ur selling otm puts. you can generate over 10%+ annualized return easy atm. of course the party ends when the price drops or rises. either u take ownership or u dont like the higher price point. if price remains same. ur making 10% easy.
also. sell call buy stock is selling a synthetic put. they are essentially the same but with a few differences.
by selling a ssynthetic put, you are forced to sell on the upside.
by selling an actual put, you buy on the downside.
transaction wise. selling an actual put is better. tax wise as well. i think.
With a covered call, the risk is that if the stock runs away from you, it gets called away and you only get your target profit. Since you were long presumably because you thought the stock was going to rise, this ends up defeating the point, unless it rises less than the per-share premium you received.
As I think about it, this looks like a good strategy for stocks that you think are mildly underpriced. You buy the stock at its current price and sell the call at what you think is its fair value and keep the premium. This automaticaly takes you out of your trade when the stock reaches its price target, and frees up cash to go into your benchmark and/or some other opportunity.
Selling puts is a sensible strategy for stocks you think are mildly overpriced. You collect some premium, and you take control of the stock when it’s priced reasonably.
If you think something is vastly under or overpriced, presumably you want to own the thing or short it directly, rather than take the chance that your investment thesis is right, but you never actually got to own the instrument that would make it work for you.
The stuff you learn on AnalystForum, surprisingly useful.
My general mode of operation is “reluctance to buy”. There are assets all over the world to choose from, if I can’t something with a bright future at a stupid low price (oil high20s, A-shares in outright panic, AAPL at $99) then I just pass. If there are many steals I’ll lever up, otherwise I sit in cash. Selling puts would seem to work well with this strategy, as I get paid to wait. Currently I’m already over 1X, so it’s extra income, and I’ll lever up a bit more if a great deal happens. Two ideas…
ASHR Oct30 puts pay $3900 to take a $100K position at $29.50. I imagine some dork wants to limit losses should we get another leg down in CN, but 1) I think the market overestimates the probability of another drop and 2) that’s the price at which you should be buying not selling, as gov support will certainly come at those levels. So someone is going to pay me 4% to maybe take those cheap shares? I might have to take that deal sir, thinking.
USO Dec18 puts pay 2.4% while waiting for the equivalent of around $35 WTI. I’d like to buy oil at $35, $30, and $25 if we see those prices next year, so this might be an interesting way to get in.
The point I was trying to make earlier is that many investors see covered called and short puts as different and to be used differently, as you have suggested here. What I was saying is this is probably incorrect, as there is no difference between a covered call and a short put, nor can there be under a no arbitrage scenario. They are exactly the same trade, other than margin interest on the intial cash flow (which should be baked into the put price). Why? Because if the two trades weren’t identical, you could implement a covered call and buy a put and you’d have a risk free profit. The best way to understand the risks/returns of a short put strategy are to just look at it as a covered call as folks are generally more comfortable/familiar with that. One strategy is not better than another for certain pricing scenarios, they’re the same.
This is my thought. Originally I was thinking it would be useful for rebalancing, but the premium would be too small unless you are rebalancing a large % of the portfolio. Now, I think it could be especially useful for implementing new accounts (outside of a 40 act fund context), since that will let me generate premium on a larger portion of the portfolio and buy at a price that, if I’m being disciplined, I should buy at anyhow.
I’d be warry of only writing Puts to manage an entry without an offsetting one at a lower strike. Surpise gap downs can force you to buy something based on headline risk that would change your intial fundamental premise.
I’d probably consider selling ITM and spreading a buy below a floor target that you would exit your trade if you bought the underlining - kind of like a stop out. You gain exposure and more leverage from the proceeds of the ITM short option, could use it to buy something safer that has a yield greater than the yield you would have seen through owning the underlying.
I get what you’re saying, but it’s not quite as simple as that. The payoff to a covered call is the same as a naked put *at expiry*, but not afterwards and not even before (puts tend to have higher implied volatilities than calls, because they are seen as insurance by a large number of those who buy them). Since you are using these puts or calls to enter positions that you plan to hold for longer than the time it takes for the option to expire, the fact that you end up holding the asset under one scenario and not under the other does make a difference, particularly if you are counting on some kind of carry, like dividends.
I agree that it doesn’t make sense to write a naked put unless you buy one at a lower strike price to limit your exposure to large gap downs. When you’re writing puts and calls, you can lose many multiples of what you gain in premium, which is why a covered call is generally considered safer than a naked put: even if the P&L functions are identical, the covered call automatically has devoted collateral; the naked put may or may not, depending on whether the investor or their broker is smart enough about leaving sufficient cash uninvested so as to make the put effectively unlevered.
^ If you sell a $15 put or write a $15 covered call, your ownership situation after exercise is identical. At expiry you have the stock if its below $15 and don’t if its above $15. It’s 100% identical. The difference is you get dividends and/or pay interest on your margined for the covered call, but these must be priced into efficient option prices, otherwise there would be risk free arb opportunities. There is an irrational bias towards selling puts to “enter positions” that I’m trying to weed out a bit here. I get that you don’t own the stock until (unless) the put is exercised. But the same is really true for a covered call, you are short 100 shares per call sold unless it’s OTM. They are the exact same trade, before and after. And making more money on implied volatility? No. If he short put is worth more than the covered call, then sell the put, sell the shares and buy a call and you’ve got unlimited risk free arb profits. Doesn’t materially exist.
^ but your strike is almost always different. it’s rare to see someone writing ITM covered calls or ITM naked puts. its a conversation for theory only because virtually nobody does this. you really want me to compare writing a put ~10% OTM and buying a stock and writing a covered call ~10% ITM? who the hell would write a 10% ITM covered call? you get basically no time premium at that price point and you add a transaction cost, plus spreads on far ITM options are usually $hitty relative to the total time premium. for the reason you stated, there’s no point in considering the stock + ITM because the number of transactions almost always makes the put favourable because it is likely arbitraged by people with no transaction costs.
^ You’re making my point for me! Who would write a ITM covered call? I don’t know, its not a great trade. But its EXACTLY the same trade as a short put. It just has a different name. Map out the payouts and you’ll see. There is no difference. Take a real world example if you want. This is why I think selling puts is highly overrated
the only reason why owning a stock and selling an ITM covered call is bad is because a short put is better. i get your point but imo, shorting puts is by far the option of choice because it is not only economically better due to transaction costs, it is easy to understand whereas buying stock on margin and selling an ITM call just seems strange, especially when working with less savvy people.
one more thing to mention, the put-call parity only really applies to those with no transaction costs and extremely low margin costs. as a retail buyer, if you’re incurring huge transaction costs and your margin costs are 4-5%, sell puts is far far far more superior than the other side of the put-call parity. the market’s put-call parity will always be very different than an individual retail investor’s investment set. this is why i stand by my argument that shorting puts only really makes sense as the cheapest form of leverage available for retail clients, on average (mostly dependent on your option transactions costs).
so again, in theory you are correct but in practice wherein the put-call parity does not hold for retail, you’re wrong.
^ Shorting puts doesn’t give you leverage though. You have no upside. All you’ve done is become an insurance salesman and you’re earning some side income. And your trying up a big chunk of margin to do so. Yes, the insurance business pays pretty good, but then you hit a Lehman and you look like a fool in a hurry.
no upside? your upside is you get paid if the stock/market doesn’t fall 15% in 3-6 months. i suppose you suggest just buying stock on margin and realizing the full brunt of that decline? all financial transactions come with different risk levels. if you’re willing to buy a stock, you should be willing to short a put, at least philosophically.
if the market is going to go up long-term, your return from selling OTM puts should be relatively close to your net annual premium as you sell them at the bottom of a market just the same as at the top. can it bankrupt your account, sure, but don’t fully lever so that you lose everything when the market falls 30%. selling puts is an easy way to add leverage when you feel we’re close to the bottom of the market. i’d feel pretty comfortable throwing on tons of naked puts after a 30-50% decline.
Remember that put-call parity says put+cash = stock-call where put and call have the same strike prices.
A lot of people forget about the cash part, because they’re looking at the profit vs change in price, and not the required assets to put on the position.
This means that the put looks a lot cheaper to do than the covered call, because people think “With the put, I’m out the premium, but with the covered call, I gotta buy all this stock first and then get a little back when I sell the call.”
As a result, with the put, you have all this cash hanging around (if you’re responsible), and your client is sitting there asking you why you are so lazy and aren’t fully invested. Over time, it’s easy to mess up the accounting and figure that you aren’t taking on enough risk.
But most people forget that they need a bunch of cash, figuring that they can borrow it when needed. Of course, the moment that it’s needed is the moment that the stock takes a dive, and that’s precisely the point when you might not be able to borrow it.
My point about the covered call vs the naked put as strategies to deal with minor over and undervaluation assumes that the options are OTM to begin with.
What I mean is that if you think a stock is mildly underpriced, you buy it and sell an OTM put at what you think the proper value is. If the stock is at $95 and you think it should be $100. You buy it now, and sell an OTM call at $100. This gives you some premium now and takes you out of your trade if it gets to fair value at $100.
If it’s trading at $105, and you think it should be valued at $100, then sell the put at $100, collect some premium, because you’d be content to own it at $100. This assumes that it’s a relatively small part of your portfolio and that you’d be willing to sell some of your benchmark to cover acquisition costs at $100 (even if what you do immediately after is sell the stock and reinvest in your benchmark). Don’t do this if your transaction cost analysis doesn’t justify it, of course, and you probably want to buy a deeper OTM put to limit your risk in case of a market crash (which you might also want to do in the covered call case, although with the covered call, there’s also the option to sell the stock).
Remember what “fairly valued” actually means for a stock. Fairly valued means that it’s priced so that the expected return on its earnings is commensurate with the amount of risk you’re taking by owning it.
People bandy about “oh, it’s about fairly priced” as if they are gurus, but any analyst who says “this is fairly priced” (or even those who say over/under) must be able to say three things 1) what the price is today (usually easy), 2) what the expected earnings are for a long time into the future, and 3) what rate of return they are expecting on those earnings (what discount rate is fair, given the risk). And they really should be able to say 4) what measure of risk are they using, and 5) how they turned that risk into an expected return.
If they can’t do that, they’re charlatans and poseurs (yes, with a U).
Strange discussion. I do both. I sell calls to exit and sell puts to enter when I think implied volatility is a little high and out of wack, and there is a solid market for the specific derivative. Spreads can eat up any potential advantage. Otherwise, all that using puts to enter and calls to exit does is smooth out your return distribution and cost you money in the long run. It’s a negative sum gain once you considered transaction costs, unless you played the volatility right. And of course, options can be used to add huge leverage. Far greater than buying on margin would ever allow.
In regard to using options in client accounts, no issues if it is a deferred account. not naked by regulation. Using them in taxable accounts can cause some tax reporting headaches. And if the client is queasy about options, a little education is needed.
And I’ll put a little support behind geo. He’s right, but I’m not initiating a “covered call” when I sell. I’m not buying the underlying and shorting the call. All I’m doing is selling the call. I already own the underlying. Shorting a put does not yield the same return as shorting a call. Shorting a put does yield the same return as buying the underlying and shorting the call at the same time and strike. Big difference.
Wasn’t all this covered in the CFA curriculum. I finished in 2011, but I’m guessing it is still in there.
The curriculum I took (finished in 2009) went through the payoff strucutures and put-call parity, but didn’t really talk much about the strategy of using options in portfolios.
In any case, I don’t deal with options on a regular basis, so this stuff is a little rusty in my mind.
All I was trying to point out is the two option strategies are exactly the same, so when you’re selling naked puts, just think “would I sell a covered call here, does it make sense?” Most of the time it doesn’t. I’m of the opinion that selling puts is generally not a good strategy. Taleb was behind that to some extent… You’re just becoming an insurance company covering risks that cannot be statistically defined. You might as well buy the stock, or use the limit order. That’s my two cents.