CL, you have delivered what may well be the politest ass-kicking in ET history.
How much do you have to know?
- Thread starter gritsking
- Start date
That is where our disagreement is. I'm not saying you're inherently wrong, but I wouldn't recommend a CC strat on individual illiquid equities. They are better suited to SPY, QQQ, and other index trackers. They are for the guy who really has no skill in predicting direction so he really shouldn't be trying to time the market anyway. If done in SPY, the synthetic scheme is perfectly legit over the long term, and consistently beats the conventional CC strat by about 3-4%.
This is also true of my point regarding the 10-y note. The risk you speak of is purely short term risk. Sometimes the rate risk will cause you to lose money, and sometimes it will make money. Over the long term, all speculative fluctuations equal out and your return equals the average yield for that period if your entries are random.
I'm suggesting a period of 5, 10, or 20 years here. Which is the mentality that a CC trader should have. Just my opinion though.
Quote from Random.Capital:
CL, you have delivered what may well be the politest ass-kicking in ET history.
The benefit of the discussion is that I believe we are speaking in plain enough terms that many of the novices stumbling through the boards will understand the various points, both good and bad.Well, you're entitled to your option, but I think it's ridiculous. The major indexes never have returns high enough to produce a margin of safety. Thus you have massive downside risk whenever long an index that can be mitigated by instead correctly choosing individual stocks for this sort of strategy. In the example I gave, LLY never really dropped below 30 even though the market bottom was months away. There was a reason for that.
The risk in being long the 10-year note is MASSIVE. You could easily be earning negative real returns for a decade even if you think the inflation hawks around here are overblown (which they undoubtedly are). That huge risk is why the 10y pays 3.45% and the 13week pays jacks shit. The 10y is NOT just 40 13weeks strung together.
C'mon now, if you criticize me for not reading for comprehension then you have to do likewise. On both points you ignored what I was advocating. To me, the covered call is for Joe Six Pack, who really doesn't have any stock picking skill. This is for a couple reasons.
- If he is good at picking value stocks, then the intent is to take advantage of the potential run higher as the market realizes the true value. CCs don't allow for this. He might claim that he will just hold the long underlying until the big move and then after that he'll sell the calls to increase returns. But if he is that good at picking value stocks, why sit in a position that is no longer a value? He should be taking profits and looking for the next value.
- OTOH, if direction is the skill rather than stock picking, he would again realize lower returns as the covered call is simply a weak hedge in this case. He would benefit more via diversification, if he has a directional edge.
But if neither of those two are true, then he really doesn't have a particular trading skill, and stats say that profitable picking attempts on his part are just luck. Over the long run he will likely be hugely correlated to the broader market. In this case he would be better served by trading the broader indexes over the course of his investing career, and taking advantage of dollar cost averaging.
On the other point, I specifically stated that I was speaking long term and not about any current situation. Over the past 25 years real returns from my suggested strat would've exceeded expectations almost every year. Indeed, you can argue that there currently exists a possibility that real returns on a TNX investment would be negative for several years. But he still gets the additional nominal returns from those notes to offset the inflation. In the conventional scenario he doesn't even get this nominal increase, so the synthetic still outperforms the conventional by the average annual yield (usually 3-6%). Considering that SPY averages 9-10% with dividends, he is increasing nominal returns by 30-40% with only default risk to consider.
Honestly I don't think it's THAT hard. When you see a stock that definitely won't pass the dividend yielding 6% over the 13week rate, buy it. Assume some sucker will take it off your hands 20% higher. Sell CC ATM when that price is hit. If you get cash, great. If you keep the stock, great. Lather, rinse, repeat. If you look at the LLY chart, you would have gotten 40% capital gains, collected 5 dividends totaling about 8.1%, and sold covered calls worth about 9% between October of 2008 and April of 2010. Not a bad way to put your capital to work for a year and a half. Trying to grab 3% on T-bonds has nothing to do with it.
To be clear to any novices who might read this. I do not prefer covered calls. I do not trade covered calls or any synthetic version of them. In fact, I trade futures because I do in fact have an edge there. But if you don't have a realistic trading edge, then this is the method that will smooth out your returns and allow you to utilize capital more efficiently.
After that you'll have two scenarios as the SPY price fluctuates up and down. Your puts will either be in the money or out.
This strategy will significantly smooth out returns over the years (long term) and statistically outperforms the underlying by a significant amount (usually several hundred basis points).
- Utilize SPY for your long term investing, because it is incredibly liquid in both the underlying and the options.
- Contribute the same portion of your income to your portfolio every month regardless of SPY price.
- Figure out how many shares of SPY you could get with your cash value (without leverage).
- Use the implied volatility of the options to determine what a one std. deviation move in SPY would be during the upcoming month, and use the amount to determine which put strike to sell.
- Sell an equivalent number of puts (remembering that 1 contract = 100 shares) the day after the third friday of each month.
Do not purchase the SPY shares! Any good options broker will only require a fraction of your cash balance as collateral for this naked put trade.
- Invest the remaining cash balance that was not used for collateral, to buy the ten year note. (or something else that is highly liquid, very safe, and offers a similar yield.)
After that you'll have two scenarios as the SPY price fluctuates up and down. Your puts will either be in the money or out.
- If they are OTM, just let them sit until they expire worthless, and the following monday, sell the appropriate amount. Also let the fixed income investments sit. You'll still need to pay some attention to ensure that you are meeting the margin requirements, and liquidate notes as needed. Never assume that margin requirements will remain constant.
- If they are ITM, you'll need to pay some attention to them as they are American and can be early assigned, although this rarely happens unless they are very ITM and close to expiration. The day of expiration if you choose to be assigned, you'll need to liquidate the 10Y notes to replenish your available cash. Or you can simply roll out the short puts to the following month using the same 1 sigma criteria as above. The easiest way to do this is via a single calendar spread. This may require a certain amount of liquidation of your notes to provide cash. If so, immediately reinvest any available capital once the new put position is established.
This strategy will significantly smooth out returns over the years (long term) and statistically outperforms the underlying by a significant amount (usually several hundred basis points).
I'm not implying that it is THAT hard for you or me or many people around here I would assume. Stats say that it is at least that hard for the vast majority of traders and investors. And some 99% of people writing covered calls are not doing it that way. Remember, it is hands down the most popular options strategy out there.
The thing I don't like about your approach is that it has a portfolio beta of 1 in all crashes (actually slightly less due to the 10y notes, but that's quibbling).
My approach will typically have a beta of about .6, and that will decrease towards zero in crashes since value investments de-couple from the indexes in the later stages of a crash.
We're not solving the same problem here. My strategy is inherently conservative. Yours less so.
My approach will typically have a beta of about .6, and that will decrease towards zero in crashes since value investments de-couple from the indexes in the later stages of a crash.
We're not solving the same problem here. My strategy is inherently conservative. Yours less so.
I will also point out that if you're repeatedly buying and selling the 10y notes, your claim about the long term mitigating the interest rate risk is even less true. You will have realized gains and losses due to rates.
Just as a general comment though, the long term doesn't eliminate rate risk, it creates it.
Just as a general comment though, the long term doesn't eliminate rate risk, it creates it.