Comment on what puts and calls really are.
Amy writes:
"My overall strategy is: hold stock long and also write cov calls on say 10% to 35%. Just like Willcousa, Paul & Elmer do. Cov calls means one can take advantage of a downturn and it reduces valuation issues. Have generated premiums thru writing cov calls and applied those to buying more shares (in a variety of stocks) and basically have 2.5X's the number of shares as the peak purely through writing covered calls, which means when this goes back up, the huge pain of this downturn may have been worth it. But it sure doesn't feel that way right now - my portfolio is down by quite a bit from the peak. "
I've written covered calls in the past, but have in recent years concluded that nearly all option writing, e.g., writing covered calls, is just a way to trade-off volatility for profit. If options are fairly-priced, writing options is like creating a collar. Some income is generated, but upside is limited.
Those writing CCs on Intel, for example, get a couple of bucks per share, e.g., $2 on a JUL20...I haven't looked, so I'm just making this number up as an example for talking purposes. So long as Intel stays approximately where it is, a good deal. In fact, one can, using this sort of number, write a similar CC a few times a year. A nice little income. However, what if Intel goes up and the shares are sold out at $20 instead of $28? Those writing covered calls during Intel's "Long March" upward often found this was exactly what happened.
In fact, this is precisely (of course!) what those who are _buying_ the CCs are anticpating.
So, who is right? Well, efficient market theory (which is not perfect) basically gives us the answer: a wash.
Options are useful for managing risk/volatility. A farmer wants a stable price for his product, so he uses the options market to manage risk. A speculator hopes to make a lot by speculating, so he trades in options.
Other issues which complicate the analysis are the tax status of those selling CCs. Is generating ordinary income on a CC writing better than taking the capital gain? (I concluded "No.")
There's also the issue of number of shares one is writing a CC for. Frankly, writing CCs for some piddling number of shares, percentage-wise, is not too interesting. Getting the aforementioned $2 a share for my entire holding would be more interesting (and anyone who thinks CCs are good for a fraction of the holding really ought to see that the same logic applies to the entire holding: in for a penny, in for a dollar).
But I wouldn't want my holdings taken away at $20 and thus incur the full cap. gains burden. (Nor would I want to have to buy back the options to stop the sale from going to completion.)
I concluded some years ago that if I need actual money, cash, there are better ways to get it than by writing CCs on my holdings. For example, margin debt.
I know some folks who were buying a lot of calls and selling a lot of puts during the Tech Boom. It was easy to make money this way. This was why "day traders" were covered so much (no pun intended). And on the slide down the sellers of calls and buyers of puts tended to do well.
The catch is simple: no one knows which direction things are going. If we knew Intel were to start going up, would we sell calls, even covered calls? No, we would be _buying_ calls and selling puts.
But we don't know this. Anecdotal reports that Joe made money by selling Intel puts, or that Fred lost a lot of money by selling calls, or whatever, are just that: anecdotal.
Options have their place. Managing risk and volatility is a standard reason. As part of an investment strategy, for investors paying high marginal rate taxes on the ordinary income generated, I don't see the attraction.
--Tim May |
