Unfortunately your initial post had static analysis all over it when describing how all the small gains would or could be wiped out by one move because of the odds game. That assumes same position size. Also, my recommendation to novices is deep out of the money and is the most responsible strategy for a novice. You must shop for low commissions.
Covered call is more risky than it appears?
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Unfortunately your initial post had static analysis all over it when describing how all the small gains would or could be wiped out by one move because of the odds game. That assumes same position size. Also, my recommendation to novices is deep out of the money and is the most responsible strategy for a novice. You must shop for low commissions.
I'm glad your system has worked for you so far. I just have two questions.
1) What % return on margin do you look for when you open a position?
2) Reg-T or risk-based?
From what I can see, these two issues make it unsuitable for the novice.
I should also mention that I'm not against selling premium as a way to generate income, but for the novice I would never recommend selling naked premium.
FullyArticulate, you do know RMBS annouced earnings after market close today, don't you?
"It depends on how you define "edge", I suppose. I could sell a RMBS 65 call today for .20. I believe I have a 99.999% chance of it expiring worthless in two days. I'd call a >99% chance an edge. The purchaser disagrees, obviously."
It is just silly to sell these cheap but dangerous options right before earnings. Say you win 20 cents 99 out of 100 times, a nice $1980. The 1 time that option becomes ITM say $20, you lose $1980.
What edge? I don't see any.
"It depends on how you define "edge", I suppose. I could sell a RMBS 65 call today for .20. I believe I have a 99.999% chance of it expiring worthless in two days. I'd call a >99% chance an edge. The purchaser disagrees, obviously."
It is just silly to sell these cheap but dangerous options right before earnings. Say you win 20 cents 99 out of 100 times, a nice $1980. The 1 time that option becomes ITM say $20, you lose $1980.
What edge? I don't see any.
To answer the initial question a covered call is the equivalent of a short put. Obviously less risky than a outright long cash(stock)position but i too would not suggest that strategy to a novice with a small account ( the commish is too high for the reward ex: receiving a 0.25 premium).
Of course. I don't believe it will go up 30%+ however. I have my own statistical model, technical analysis, and fundamentals reinforcing my decision. Still, I could be wrong, which is to your point.
I believe I have a 99.999% chance of my .20 sold call expiring worthless. That means 1:100,000, not 1:100.
Even if you assume it's 1:100. When I lose, I'm not going to lose by $20. That would have required a 60% upward move in RMBS. More importantly, it would have required an absolute paralysis on my part to not make any adjustments during this surprising upward move.
With adjustments, I'll probably lose by <$5. So, I have a 1% chance of losing $5 and a 99% chance of making $.20. To me, that seems like a good risk worth transferring to myself.
The point I'll concede is that I have a chance of a big loss if a catastrophic event occurs and I have no chance for adjustment. (i.e. after market close, INTC announces they're buying RMBS for $100/share). In that case I'm in trouble (although not catastrophically so--see my final point below).
A trader who wants to dip into selling premium, but who can't stomach the unlimited risk should look at:
1) Sell butterflies instead of straddles
2) Sell condors instead of strangles
3) Try ratio backspreads
Any of these strategies will turn the instantaneous, no-adjustments-possible unusual event into a relatively minor loss.
The final point I'll make is that selling out of the money calls or puts is less risky then buying or shorting stock. By selling that .20 65C, an instantaneous move to $85 means I lose $20. If I had instead shorted the stock before earnings, I would lose $40. People get in trouble when they use options for their leverage. As a rule of thumb, I'm never short more contracts then I can afford to buy or short actual shares.
With regard to question 1 , I relate everything to total liquid net worth. I never commit more than 3.5 percent of total liquid net worth to margining one particular idea. I don't double with a Martingale because that would get me overextended. My annual return on the option selling part of my trading ranges from 28 to 36 percent. As far as question 2 is concerned, I don't understand the question.
Articulate don t forget the commish in calculating risk - reward : when you pay a penny a contract to receive 0.20 that is 5% of the premium...
Sorry, I was asking what kind of account you are trading. For the small account novice to sell OTM premium, one contract is going to tie up a few thousand dollars. The return is then going to suck and he would probably be better off investing in a mutual fund. I was wondering if you trade this strategy with a risk-based haircut and can therefore avoid tying up too much margin.