Long term investing and the logics of selling options

[Pablo]

Would this be true.

With owning a stock, maximum loss is limited (100%), and maximum gain is unlimited.

With a covered call, maximum loss is limited, and actually reduced by a premium collected. Maximum gain is limited.

What if the stock goes up above the strike? Don't we buy stocks wanting them to go up? Again, if we buy an extended warranty on a vehicle, are we happy like Dougie, that it broke down a lot?

OP has a 30-50 year horizon. That's a really long time, and many stocks will go up, not down, not sideways, in that period of time.

imho the covered call works best if his stocks go sideways. Not down, not up.

Sideways, or down just a hair. This is why I like covered calls on stocks that pay decent and when I'm up and time to sell for whatever reason.

Above the strike, SOLD. Always. Computer does that. You sold the RIGHT.
+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

Here's a funny bugaboo (not really pertinent, but worth discussing.)

You sell the right.......you "hold the option", you have that cash. That covered call is on your list of positions as it should be. Suddenly or not so suddenly the stock closes in on the expiration date, or the stock prices gets closer - well that could and is a negative on paper - so much so that it's shown as a big fat RED on/in your account. Sometimes a bit large. But really your net wealth didn't go down. Just something to be aware of.

 

[zzyzzx]

Ok, let me ask a different way.

What is the value of the call your looking to sell, vs the price of the stock?

Per Pablo's post - the payment for a call option these days is virtually nothing.

Sell the stock and buy one you like that pays a dividend?

I buy individual stocks for the dividend. Sometimes it's in anticipation of a company restoring it's dividend. Sometimes companies cut dividends too. If the dividend is now insufficient, or I believe that the dividend isn't going to get restored anytime soon, I sell covered calls as sort of a replacement for the dividend until the stock gets sold off due to it rising over the strike price (sometimes dividends are restored and I stop selling the covered calls).

I like growth stocks too, but for that I prefer mutual funds / ETF's. I view my dividend generating stock portfolio as a substitute for a pension, since I will never have a defined benefit pension.

 

[SC Maintenance]

I buy individual stocks for the dividend. Sometimes it's in anticipation of a company restoring it's dividend. Sometimes companies cut dividends too. If the dividend is now insufficient, or I believe that the dividend isn't going to get restored anytime soon, I sell covered calls as sort of a replacement for the dividend until the stock gets sold off due to it rising over the strike price (sometimes dividends are restored and I stop selling the covered calls).

I like growth stocks too, but for that I prefer mutual funds / ETF's. I view my dividend generating stock portfolio as a substitute for a pension, since I will never have a defined benefit pension.

Sounds like a good plan. The risk of course is if they restore the dividend, the stock might climb and your call would be executed. Obviously you understand this.

I would have to assume calls haven't always been this cheap. The VIX is almost to nothing. Its implied that stocks only go up, so no one wants a call - they just buy the asset I guess?

 

[zzyzzx]

Sounds like a good plan. The risk of course is if they restore the dividend, the stock might climb and your call would be executed. Obviously you understand this.

I had it happen last week! Second time on that particular stock too. I'll probably wrote a put on in case it drops enough to interest me again. I'm not going to name the ticker symbol, but it seems like for this one particular stock if I sell puts, the stock always drops. If I sell calls, the stock always rises.

I would have to assume calls haven't always been this cheap. The VIX is almost to nothing. Its implied that stocks only go up, so no one wants a call - they just buy the asset I guess?

If you happen to own a stock that you really don't care if you own it, you can sell a long term call, like a year. Those pay out really well. I've done it, a few times. On at least two occasions the stock rose well above the call price, but dropped back down before the expiration date and were never exercised.

 

[MRC01]

Even naked options can be, but aren't necessarily, high risk. They can also be used to reduce risk.

For example, selling naked puts. Suppose you want to buy a stock that's currently trading at $50. You'd like to buy it at $45, so sell a naked put with a strike of $45. Now you pocket the premium as cash and wait until the expiration date. If the stock stays above $45 your put never exercises, you keep the premium, and if you still want that stock you can sell another put. Keep going, making premiums in each round, until your put finally exercises. If the stock drops below $45 your put exercises and you buy it for $45. Well you actually paid a bit less, $45 minus the premiums you got paid up front along the way.

Worst case, the stock tanks to zero and you're out $45. Even then you're better off than if you had bought the stock outright, because your premiums offset some of the loss. So the end result is you buy the stock you want, eventually, while making premiums along the way waiting until the stock hits your strike price. Selling the naked put reduces risk and increases your gains, compared to simply buying outright with a limit order of $45.

Another aspect to consider in this approach is the cost of delay. If the stock shoots up to the moon while you're selling your puts, you still earn your premiums but you miss out on that upside. But then you'd also be sitting on sidelines missing out on that upside if you instead did a simple limit purchase order at the same price of $45. And you wouldn't earn any premiums. So selling the puts didn't make you any worse off. The only way to capture that upside is to buy the stock now and expose yourself to the potential downside.

And this downside can be mitigated. If the stock shoots up after you sell naked puts, you can buy your puts back to close your position. And since the stock increased in price, the puts you sold will be cheaper - you'll pay less to buy them back and you'll still make money. Then you can open a new position.

 

[Pablo]

Even naked options can be, but aren't necessarily, high risk. They can also be used to reduce risk.

For example, selling naked puts. Suppose you want to buy a stock that's currently trading at $50. You'd like to buy it at $45, so sell a naked put with a strike of $45. Now you pocket the premium as cash and wait until the expiration date. If the stock stays above $45 your put never exercises, you keep the premium, and if you still want that stock you can sell another put. Keep going, making premiums in each round, until your put finally exercises. If the stock drops below $45 your put exercises and you buy it for $45. Well you actually paid a bit less, $45 minus the premiums you got paid up front along the way.

Worst case, the stock tanks to zero and you're out $45. Even then you're better off than if you had bought the stock outright, because your premiums offset some of the loss. So the end result is you buy the stock you want, eventually, while making premiums along the way waiting until the stock hits your strike price. Selling the naked put reduces risk and increases your gains, compared to simply buying outright with a limit order of $45.

Another aspect to consider in this approach is the cost of delay. If the stock shoots up to the moon while you're selling your puts, you still earn your premiums but you miss out on that upside. But then you'd also be sitting on sidelines missing out on that upside if you instead did a simple limit purchase order at the same price of $45. And you wouldn't earn any premiums. So selling the puts didn't make you any worse off. The only way to capture that upside is to buy the stock now and expose yourself to the potential downside.

And this downside can be mitigated. If the stock shoots up after you sell naked puts, you can buy your puts back to close your position. And since the stock increased in price, the puts you sold will be cheaper - you'll pay less to buy them back and you'll still make money. Then you can open a new position.

Nice write up. I would just say by the very nature selling a put is naked, but all brokers make sure you have the cash or margin credit.

 

[MRC01]

Nice write up. I would just say by the very nature selling a put is naked, but all brokers make sure you have the cash or margin credit.

If you're already short in a position, selling a put on it is considered "covered".
Either way, you better have cash on hand in case the puts exercise.

 

[zzyzzx]

Always check when the next earnings and dividend dates are when doing any type of options and plan accordingly!

 

[Dave Hess]

Some folks got killed trying to short Tesla.

I don’t do any options…… just leverage / inverse ETFs of various sectors depending on market momentum.

 

[PandaBear]

Thanks for all the posts. I've been studying and learning about this in the last 2 months and want to see what I want to do actually with options. I come to the conclusion that:

1) I want to be on the selling side (covered call, naked put) with spread and / or rollover to limit my risk. I haven't learned all the strategies out there yet but my goal is, if I were to sell a call at price X, I'll buy a call at price X+N, and if I were to sell a put at price Y, I'll buy a put at price Y-N, etc. This way I would have my extreme scenario covered and protected, at the expense of leaving some money on the table. I'm ok with that.

2) I want the law of large number to work for me. Basically I want to setup a system where I would sell some options (with spread), and get like a profit loss ratio of slightly above 50%. It is like "be the house" that over time I would make money. Over time, it would be like insurance company or casino, where they have a small edge in profit, and hedge their risks with a re-insurer to protect against large losses. The concern would be how much stock and money I need to "sit there" that I cannot use to invest elsewhere.

3) I want a statistics based system to not make big money, but to profit a small amount consistently, without too much work or emotional stress. I want it to be simple and no need for time consuming research. My guess is if I setup the options correctly I don't need to keep checking it every couple hours. If I can setup once or twice and let it run, that'll be ideal. Not sure if it is possible.