How much do you have to know?

[The Big D]

Quote from Cache Landing:

OK... let's make that assumption.

Please explain exactly what it is about those exact quotes that I'm not understanding correctly.

Please start with the idea you first proposed that in order to replicate a CC a person must first create a synthetic stock position.

There's your issue. I never said that you needed synthetic stock to replicate a CC position. I said you needed synthetic stock to represent the typical trades in a CC account. And I provided one such example trade. As you yourself just discovered by re-reading, at some points in time that trade involved just stock. From a practical POV, this makes sense - it's easier to find buyers for your volatility and in practice you will make more money when it's ATM and front month. But you want to buy your stock when it's got a big margin of safety in case you end up stuck with it.

So given that sometimes the position is just stock, to replicate it with options, one might imagine synthetic stock would be helpful

 

[sonoma]

Quote from Cache Landing:

OK... let's make that assumption.

Please explain exactly what it is about those exact quotes that I'm not understanding correctly.

Please start with the idea you first proposed that in order to replicate a CC a person must first create a synthetic stock position.

I wouldn't normally weigh-in on this type of thread, but Cache, you have got the patience of Job.

 

[spindr0]

Quote from sonoma:

I wouldn't normally weigh-in on this type of thread, but Cache, you have got the patience of Job.

Ditto. This excerpt from Big D-land is like rubbernecking at an accident in slow motion. The misinformation and behavior are indeed intriguing to observe. Or IOW, In the land of the blind the one eyed man is king.

 

[newguy05]

Quote from Cache Landing:

Whoah.... your lack of understanding is what is confusing you it seems. I'm not trying to be rude, just trying to help you understand.

It's not just lacking of understanding, he's just spewing bullshit at this point intentionally trying to bury the thread and hide his earlier remarks. I dont know why you guys even bother wasting more time with this clown. Remember the old saying - never argue with a fool - he will drag you down to his level, then beat you with experience.

 

[Cache Landing]

Quote from The Big D:

There's your issue. I never said that you needed synthetic stock to replicate a CC position. I said you needed synthetic stock to represent the typical trades in a CC account. And I provided one such example trade. As you yourself just discovered by re-reading, at some points in time that trade involved just stock. From a practical POV, this makes sense - it's easier to find buyers for your volatility and in practice you will make more money when it's ATM and front month. But you want to buy your stock when it's got a big margin of safety in case you end up stuck with it.

So given that sometimes the position is just stock, to replicate it with options, one might imagine synthetic stock would be helpful

Ok, I'll buy that.

So now let's examine what would then be required. We must replicate the stock position by buying a call and selling a put. Now once we have the synthetic, we don't then have to sell the synthetic underlying to get the naked put, we simply need to offset the long call leg.

I'll buy the argument that there are certain circumstances that would require more transactions to replicate the CC rather than simply initiating it the conventional way, but that slight bit of simplicity comes at a high cost.

At any given time you might increase your annual returns by 3-6% by the naked put synthetic and utilizing the idle cash. In a perfect world this wouldn't be the case because you would earn interest on the premiums of the calls you sold in the CC, but most brokers base that interest rate on the fed funds rate which right now gives you nothing. OTOH, you can always utilize the significantly lower equity requirements of the naked put to do a little fixed income investing and increase returns for no additional risk.

Not saying that I advocate any of this, but just that it is an option. And even though you are correct that the naked put route is more complicated than the conventional CC, it then allows you to increase returns for no added risk.

 

[Cache Landing]

Quote from sonoma:

I wouldn't normally weigh-in on this type of thread, but Cache, you have got the patience of Job.

Interestingly I don't think I'm all that patient face-to-face. Maybe the anonymity of the internet brings out the best in me.

 

[Martinghoul]

Quote from Cache Landing:
Interestingly I don't think I'm all that patient face-to-face. Maybe the anonymity of the internet brings out the best in me.

I applaud you, CL...

 

[The Big D]

Quote from Cache Landing:

Ok, I'll buy that.

So now let's examine what would then be required. We must replicate the stock position by buying a call and selling a put. Now once we have the synthetic, we don't then have to sell the synthetic underlying to get the naked put, we simply need to offset the long call leg.

First off, yes, you can do that. And it involves more than puts, which was all my point was. The weenies who claimed puts were all you need were simply wrong.

However, again this has a hidden implication that sinks it. In order for it to work, the synthetic stock has to be built using the desired sell price as the strike. Which is doable (you know that price ahead of time) but isn't liquid at the time you want to buy the stock. So again you take it in the ass from the market makers.

I'll buy the argument that there are certain circumstances that would require more transactions to replicate the CC rather than simply initiating it the conventional way, but that slight bit of simplicity comes at a high cost.

This is nonsense - in order to earn 3-6% in bonds, you have to take on either default risk or interest rate risk (or both). The risk free short term rate is the same 0% your broker will give you on your cash. There's no reason to think that evaluating default risk or interest rate movements should be part of a covered call portfolio.

 

[Cache Landing]

Quote from The Big D:

First off, yes, you can do that. And it involves more than puts, which was all my point was. The weenies who claimed puts were all you need were simply wrong.

Fair enough

However, again this has a hidden implication that sinks it. In order for it to work, the synthetic stock has to be built using the desired sell price as the strike. Which is doable (you know that price ahead of time) but isn't liquid at the time you want to buy the stock. So again you take it in the ass from the market makers.

Not exactly. A Long Call/Short Put combo at ANY strike is a synthetic long stock, as long as the strike is the same for both sides. It doesn't have to match the target sell price of the stock. It seems you might actually be referring to the point at which one would desire to sell the call against an underlying equity. In that case you might be right sometimes. Really depends on the underlying and how far out the person would want to go. SPY for example is liquid a really long way out and trades in 0.01 increments.


This is nonsense - in order to earn 3-6% in bonds, you have to take on either default risk or interest rate risk (or both). The risk free short term rate is the same 0% your broker will give you on your cash. There's no reason to think that evaluating default risk or interest rate movements should be part of a covered call portfolio.

Well, technically you are correct, especially considering that an actual risk free rate is purely theoretical anyway. I was referring more to instruments utilized as essentially risk free investments. Highly liquid and extremely low default risk. Something like the 10-Y note. The average investor considers these risk free for all intents and purposes, and many managers use the 10-Y yield as the risk free rate in their calculations. Also, I wasn't speaking about right now, but rather the expected average over the long run.

Also, I'm not saying that we can assume that a conventional CC strat would seek to increase returns through efficient use of capital. What I am suggesting is that the option is there for someone who knows how to do it. A 30-40% increase in profits for very little extra work or risk.

 

[The Big D]

I realize you can build synthetic stock at any strike in theory, but in practice you can't. A lot of the options on dividend stocks are only really liquid ATM and front month or 2. Anywhere else, you will be taking market made by 1 or 2 people, not making one for 100. Prices will suck accordingly.

So in the LLY example, what you end up doing if you want synthetic stock is building it at the 30 strike or thereabouts initially. Then each month you have to roll it. But at that point, your options probably aren't ATM any more, so rather than getting raped by the MM on a monthly basis, you have to exercise and take the underlying. Right there, your clever capital allocation scheme is screwed, because you temporarily have to hold the real stock. Now, if you want to you CAN sell the real stock and re-build your synthetic stock at the new strike for efficiency purposes, but you'll face the same problem next month.

Then when you get to the point when you want to sell 36 calls (or equivalent), you're stuck - you have 30 calls instead. So you can't just leg out of your position. You have to liquidate, at which point you can sell 36 puts. And if the expire ITM, you again have unwanted stock and have to do cleanup again. Alternately you can keep your synthetic stock and sell calls at 36, which again is anything but "just puts".

Synthetic stock is much more problematic than people believe.

Oh, and considering the 10Y Tbond risk free rate of return right now is absurd. It's pricing is entirely driven by rates/inflation bets. There's very real risk.