Hi Steve:
I think it is more important to keep track of Portfolio Equity than Portfolio Value
My intent was to use 'portfolio value' as a simple sum of current equity value plus cash, I wasn't aware that the term had a formal definition. Margin wasn't considered, any significant use of margin contradicts the conservative covered call strategy.
[multiple buyback/rollup example, covered strategy loses to uncovered] It would seem to me that with this strategy you are kind of shooting yourself in the foot since the original reason for owning NTAP was capital appreciation.
Well, actually no and no. The covered call strategy we've been discussing is intended for downside protection and income generation. The strategy calls for looking at the equities as a lump cash generation machine, with per share values secondary. For example, if you can take a $400k lump of equities and generate an average $20-30k taxable a month from it, then it matters little if in five years the lump is still worth only $400k. As Voltaire puts it, the goal is to separate yourself from the casino aspects of the market. BTW, he typically recommends only doing this with stocks that one would want to own long term, and that only half of one's position in each stock be covered, the rest remaining open for capital appreciation. A long term bull market is assumed.
The strategy is a known loser relative to holding stock long, during those specific time periods when the equity increases sharply in value. Ref McMillian quote in post #29615 for example. OTOH, it is a clear winner IMO during sideways or falling stock prices.
Another point that was implicit in earlier posts in the discussion but not in my or your analysis, is that we were discussing whether the buyback/rollup strategy is suitable for a stock that has slid way down, thus the investor would presumably have been writing profitable covered calls on the way down, and has now been 'caught' writing covered calls at the bottom of the market.
If calls have been written and bought back during the stock's drop, then some of that cash could be invested into purchasing additional shares of the stock during the subsequent rise.
Re your example of gain/loss in the portfolio during NTAP's price rise from $95 to 125, with 22% results vs 32%, I would say that this investor has benefited by about two thirds of NTAP's appreciation. Throw in the delayed gratification of the $5-8k tax benefit, and it's roughly a wash.
If we throw in some time decay, saying that the last buyback/rewrite is a rollout at expiration (realistic I think), then that cuts off $6 or so in premium, and raises the gain 29% versus 32% for holding long, and the tax loss puts the return over the 32%.
I *was* wrong in my original post to imply that a series of buybacks/rollups would beat a holding long stock with a sudden appreciation of say 40 or 50%. Though I think it wouldn't be far off as time decay is also working constantly in the favor of the option writer.
A series of buybacks/rollups is I think always superior to allowing your stock to be called away during a strong rebound from a market bottom, assuming that you got caught writing calls down there. <g>
In real life, all this would require attention to the market and execution.
Alternatively for a 30% NTAP rise between write and expiration, a single buyback/rewrite just before expiration would give per share: +9.5 (10%) initial write, -30 buyback (zero premium at 30% ITM regardless of time), +30 share appreciation, and +12.5 rewrite (rollout), net +$22 (23% from $95). Breakeven with the original 3 buyback/rollup example, plus slightly higher tax loss. Worse than the second 3 buyback example with time decay.
If stock increases 21% to $115, single buyback/rewrite at expiration would be +9.5, -20, +20, and +11.5 (rollout), net +21 (22%), plus 10.5/share tax loss, versus 21% holding long.
For the 21% example, two buybacks/rewrites with full time premiums would be +9.5, -16, +10.5, -16, +11.5, and +20, net +19.5 (20%). About breakeven. But two buybacks/rewrites with the second at expiration would be +9.5, -16, +10.5, -10 (zero premium), +11.5 (rollout), and +20, net 25.5 (27%). A clear improvement over holding long or a single buyback/rewrite, IMO.
You gotta love that time decay!
So, given that you've already written the calls, and are able to execute at least one buyback/rewrite prior to expiration and one at expiration, then breakeven is around 30% stock price rise. Less than that, and you beat holding the stock long. More than that, holding the stock is better. Good argument for choosing stocks that seldom change by more than 30% a month (I think NTAP slips under the wire there, but CREE and ELON don't have a chance! <g>).
Until that time, thinking that you already have a profit is just an illusion.
Agreed. A consensual reality among consenting adults. As I phrase it to friends, "Everything in the market is imaginary except for the cash you take out and put in a bank". But in the meantime, while we're playing, we *do* need a way to keep score.
In a more serious vein, yes, a tax loss doesn't put food on the table this month.
Enjoyed your comments Steve.
- Dwayanu |
