Is covered call writing on dividend stocks the holy grail for the semi risk averse investor?

[Daal]

Lets someone is semi risk averse, what that means is that person cant just buy SPY and hold it forever, the person will panic during market drops. I believe that is the vast majority of investors out there, in fact, some studies show people make 2% a year against 8% of mutual funds due these emotional tendencies.

But if the person buys good dividend paying stocks and supplements that income through call writing, now all the sudden the person finds that through that extra income (say 5-6% a year of div+premiums) then that person can pacify that tendency to want to sell during market drops, specially as that person accumulates dividends and premiums over time, it gives them the sense that the stock is a "cash cow" and its not a big deal to see a temporary drop.

All of the sudden that huge underperformance versus the index, turns into a small underperformance. Sure, that investor would probably be better off just buying those stocks and holding it no matter what, due the trading costs and taxes involved with covered calls, but that ignores those sales made at the market lows when emotions take place, that is the biggest cost of all. Covered call writing looks to me like a great strategy that should be implemented by a lot of people, instead of trying to force people into doing something that have proven unable to do like economists and personal financers seem to be doing.

 

[stepandfetchit]

IMO: Has the appeal of a sharp stick in the eye for me! (not my holy grail) ;-) A bearish trade (Call Write) on a Bullish position, seems a bit schizoid. If one was good at swing trading and pick the sale of the Call near resistance, it would seem fairly ideal, however I don't have the skill set needed for it.

 

[Daal]

IMO: Has the appeal of a sharp stick in the eye for me! (not my holy grail) ;-) A bearish trade (Call Write) on a Bullish position, seems a bit schizoid. If one was good at swing trading and pick the sale of the Call near resistance, it would seem fairly ideal, however I don't have the skill set needed for it.

Overall, its a bullish position, just not as bullish as others

 

[Maverick74]

Lets someone is semi risk averse, what that means is that person cant just buy SPY and hold it forever, the person will panic during market drops. I believe that is the vast majority of investors out there, in fact, some studies show people make 2% a year against 8% of mutual funds due these emotional tendencies.

But if the person buys good dividend paying stocks and supplements that income through call writing, now all the sudden the person finds that through that extra income (say 5-6% a year of div+premiums) then that person can pacify that tendency to want to sell during market drops, specially as that person accumulates dividends and premiums over time, it gives the sense that the stock is a "cash cow" and its not a big deal to see a temporary drop.

All of the sudden that huge underperformance versus the index, turns into a small underperformance. Sure, that investor would probably be better off just buying those stocks and holding it no matter what, due the trading costs and taxes involved with covered calls, but that ignores those sales made at the market lows when emotions take place, that is the biggest cost of all. Covered call writing looks to me like a great strategy that should be implemented by a lot of people, instead of trying to force people into doing something that have proven unable to do like economists and personal financers seem to be doing.

No different then selling naked puts. It's a terrible strategy on so many levels. For one, the calls are going to have ZERO premium in them because they price out the divy. Two, you are giving away the upside. So if you get called away, what do you do, rush in and buy the highs? Or stay out and watch the stock double? LOL. Three, almost the entire S&P 500 pays divys now so basically you are still just long the s&p 500 at the end of the day. You might as well just buy the SPY ETF. You do know that it pays a divy too right? Pretty much about the same divy as most stocks. So why take the stock specific risk when you can just be long a basket of stocks? Oh and btw, there is a dividend ETF called "DIV" that basically is just a basket of 50 of the highest paid dividend stocks in the US.

 

[Daal]

No different then selling naked puts. It's a terrible strategy on so many levels. For one, the calls are going to have ZERO premium in them because they price out the divy. Two, you are giving away the upside. So if you get called away, what do you do, rush in and buy the highs? Or stay out and watch the stock double? LOL. Three, almost the entire S&P 500 pays divys now so basically you are still just long the s&p 500 at the end of the day. You might as well just buy the SPY ETF. You do know that it pays a divy too right? Pretty much about the same divy as most stocks. So why take the stock specific risk when you can just be long a basket of stocks? Oh and btw, there is a dividend ETF called "DIV" that basically is just a basket of 50 of the highest paid dividend stocks in the US.

You pretty much ignored the crux of my argument, which is for a lot of people, the biggest cost of ALL is selling everytime there is a bear market. IF (and I dont claim this is the case for every one) selling calls on good dividend payers can help them whether the storm, then the strategy achieved its purpose, which is to lag the market less than the alternative (selling on big market dip). In the ideal world, people would fix their discipline issues and index forever, but most investors drink coke and pay a visit to mcdonalds every week, trying to fix their discipline seems a FAR more difficult problem

 

[Maverick74]

You pretty much ignored the crux of my argument, which is for a lot of people, the biggest cost of ALL is selling everytime there is a bear market. IF (and I dont claim this is the case for every one) selling calls on good dividend payers can help them whether the storm, then the strategy achieved its purpose, which is to lag the market less than the alternative (selling on big market dip). In the ideal world, people would fix their discipline issues and index forever, but most investors drink coke and pay a visit to mcdonalds every week, trying to fix their discipline seems a FAR more difficult problem

Daal, calls carry almost zero premium on dividend stocks. Perhaps you missed that point. We option guys price that divie out. So basically he has zero downside protection and the dividend stocks will drop just as much as SPY because at the end of the day, it IS the SPY. There is no "psychological" wet blanket to comfort these people. If SPY drops 50% his little dividend toy will be down 48%. Yeah, that's a nice comfort. What will NOT be a nice comfort is when his little stock shoots up 30% without him in it because he had to write the call 2 pts out of the money just to get a .30 call sold. It doesn't work.

And again, back to my previous post, just buy the DIV etf and call it a day. At least you get rid of the stock specific risk.

 

[Daal]

If SPY drops 50% his little dividend toy will be down 48%

The buy write index was down 39% in 08-09, thats less than the 57% of the SPX(and you just said that SPY is a good div payer). That could be the difference between a huge mistake/panic sell and someone sticking with a strategy (unless you want to claim that additional losses produce no extra pain). I suspect a buy write on the DIV was probably down by a good deal less than the ETF (had it existed back then)

 

[Daal]

And yes, the buy write index lost to the index during the recovery, but if the investor panicked and sold, there is no recovery there. he will be in cash when the market pops huge

 

[viruscore1]

selling covered call is neutral strategy used to generate income. Works beautifully on low beta stocks.

 

[stepandfetchit]

me thinks two lines of thought that should perhaps be independent:
1) Selling near bottom of a correction/pullback. Been there, done that, " and I don't feel much like a man, Gus." from Gone Fishing
2) Assuming one "buys and holds" to avoid #1, then what to do with the dry powder to offset a pullback.

For #2, seems a Volatility play will be more successful (looking for Volatility to return from the stratosphere), since your signal is backward looking. (Did I just get kicked in the privates? --- An easier threshold to detect) -- ie, something like go long SVXY for a directional move.