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

[Maverick74]

What the example is not taking into account is that its not about analyzing that pain in an absolute basis but RELATIVE to the pain of a similar situation.
Its about going from $100 to $120 with large positive carry, compared to going from $100 to $120 with a small positive carry or a negative carry. Then losing it.

What's more, the carry of covered calls is counter-cyclical, since premiums go up in market drops, the investor will be paid more just at the time where he most needs it (when he is likely to make a big mistake). Looking at JNJ right now wont capture this element.

So its a carry that increases doing those money losing periods (likely more than offseting any pressure in dividends, a fair assumption in case of US stocks), whereas the 2 other strategies give you nothing (or perhaps, only the dividend cuts with no offset)

But there is more, the total drawdown is also lower with that first strategy. I have never seen a behavior finance study that proves that losing more money (when you are already losing money) makes no difference to the pain level of people. I would be shocked if that is true, it goes against all my experience. Especially if the losses are spaced out (in studies, it all happens in a day or two, whereas in the markets, an investor can be tortured for months/years, at some point they might just give up in disgust)

So to sum
-The strategy has a larger positive carry compared to others. The carry is counter-cyclical and helps the investor when he needs the most help. It is also a lot more "real" (everybody understands cash in the account) then a magical capital gain that fluctuates
-The strategy delivers smaller drawdowns. It helps the investor when he needs the most, decreasing the amount of financial stress he will face at the same he is most likely to make a mistake. This is specially important given that it looks likely that people systematically over estimate their risk tolerance (yet they still want to be 'in the market').
-There is a third element that I didnt mention before which is the urge people have to 'do something' in weak markets periods. This strategy gives them something do to (collect inflated premiums), wheareas the other strategies give you nothing which might induce the person to sell

I dont think these nuances have been captured in a behavioral study before.

Now, can you honestly say you it if 10-20-30% of the population were more likely to stick the first strategy that would be some HUGE surprise? It would be just what one would expect!

Here's the problem. One, when the market tanks, vol is not going to uptick much on these stocks on the way down as much as you think. And two, and this is the worst part, say MO sells off 10 pts. You have to write a call almost at the money. As soon as MO bottoms you will be doing EXACTLY what you are trying to avoid doing which is sell at the bottom. MO will get called away from you as soon as the stock upticks off the lows. So you will ride the stock all the way down and then sell it on the lows. The only way to avoid that would be to create a rule that says if the market sells off, you don't write any calls on the stock until it gets back to the highs. But then that defeats the whole "comfort" factor.

Look, covered calls has been pitched to mom and pop types at investing seminars for decades starting with Wade Cook who went to prison.

I'll offer a better suggestion and one that does get pitched on CNBC a lot and while I still don't like it, it's better then your version. Look for very volatile growth stocks but ones you actually like and want to own. Every earnings period sell calls against your long shares when vol spikes going into earnings. If the stock tanks, you capture the premium (comfort) and you still own shares. If the stock pops, it almost always fades. You will be able to get back in for close to where you got out factoring in the call premium. That makes more sense. Because in this version of the "comfort trade", you are selling at the highs vs the lows (having stock called away at the bottom) and you are improving your cost basis every time the stock tanks. MUCH better then selling .30 at the money calls on dividend stocks and then being forced to sell on the lows once the stock bottoms.

 

[Deuteronomy_24_7]

ones you actually like and want to own

If I knew that, I'd just buy them, rather than futzing with options.

 

[Maverick74]

If I knew that, I'd just buy them, rather than futzing with options.

But you "did" buy them. That's my point, you OWN the stocks. You sell the earnings juice because that is the "premium" the market is offering you to hold the risk going into an event. There is a real economic benefit and purpose being served. No such benefit exists for the call seller of a dividend stock as no one needs to insure against a utility or tobacco stock grinding higher.

 

[Deuteronomy_24_7]

juice because that is the "premium" the market is offering you to hold the risk going into an event.

Whether the 'juice' in those situations is too much, too little, or just right is an empirical question that would have to be studied carefully.

 

[Maverick74]

Whether the 'juice' in those situations is too much, too little, or just right is an empirical question that would have to be studied carefully.

Of course. That is constant among ALL strategies. I was simply implying that it was better then blindly selling calls every month in low vol dividend paying stocks as a way to be "comforted" from selling the lows.

 

[Deuteronomy_24_7]

I agree selling calls on divvy stocks is unlikely a-priori to be a good strategy. But I've been wrong before, and I haven't done the relevant research.

 

[tradelosses]

But you "did" buy them. That's my point, you OWN the stocks. You sell the earnings juice because that is the "premium" the market is offering you to hold the risk going into an event. There is a real economic benefit and purpose being served. No such benefit exists for the call seller of a dividend stock as no one needs to insure against a utility or tobacco stock grinding higher.

bullish on lung cancer

 

[tonynyc]

I'm using this strategy with AMAT, pays a small quarterly dividend, and I create my own dividend by selling weeklies.

 

[PaulT]

I'm using this strategy with AMAT, pays a small quarterly dividend, and I create my own dividend by selling weeklies.

Excellent, Tony.
You have converted the 1.33% dividend yield into potentially 18.5% yield. And if the underlying gets called away, you can simply find another stock and continue the process. Or, if your account size permits, run 5 or 10 or more of these every week, so if one is called away, no big deal. The "home run hitters" on here don't appreciate the slow and sure strategy of covered call writing, and focus too much (IMO) on the lost opportunity costs of missing a large uptick in the underlying.
Do you have a particular tactic in deciding which Call to choose? When I examine this using ThinkBack on TOS it looks like you are choosing the 25-30 Delta Call - is that the case, or do you have some other criteria?

 

[viruscore1]

Excellent, Tony.
You have converted the 1.33% dividend yield into potentially 18.5% yield. And if the underlying gets called away, you can simply find another stock and continue the process. Or, if your account size permits, run 5 or 10 or more of these every week, so if one is called away, no big deal. The "home run hitters" on here don't appreciate the slow and sure strategy of covered call writing, and focus too much (IMO) on the lost opportunity costs of missing a large uptick in the underlying.
Do you have a particular tactic in deciding which Call to choose? When I examine this using ThinkBack on TOS it looks like you are choosing the 25-30 Delta Call - is that the case, or do you have some other criteria?

I use similar strategy. Once called away, wait for retracement and sell otm put for assignment. Sometimes the put strike is below the call option assigned price.