Morphing a covered call into a short strangle

L

Libranalysis

I recently traded a covered call on a high volatility stock. Didn't particularly want to own the stock, but the call premium was so high I got in with a low break even.

The the stock fell significantly, IV was still high, and puts were selling at a high premium. So I sold that too.

Now I have a short strangle with stock in the middle. That strategy got a name?

As far as cons and risks, I can't think of any other than having to pony up the shares on one side thereby leaving me naked on the other. However, my break even points are a mile wide, so I don't anticipate that. I feel like I'm missing some negative aspect of this trade.

Thoughts?
 
It's called "fucked..."

Premiums are high, since vols are high. Just trying to capture that theta/premium you should've sold that strangle instead of the covered call... (not that it's my preferred strategy on high vol stocks)..

So now you have a big loss on the stock and you're trying to get some back by selling the put right? You probably have to do that multiple times... selling the strangle... but.. .if the stock drops further you'll keep receiving the stock.. so you will be more long each time that happens.

The negative aspect is that you're short gamma.... which is covered going up, since long the stock.. but going down is painfull.

I'm more of a "I screwed up and let's get rid of it"-type of guy.
 
Yup. It's called: "I don't have a stop loss, so I'm doubling down." You sold the puts instead of buying downside protection or getting out altogether.

Can you imagine having this as an ingrained habit when a bear market comes? The sad part is a short call will retain value as volatility explodes.
 
Hey, the light bulbs finally lit up. It's not as bad as you think (but I still had it wrong):

  • I received a high premium on the call so my BE on the stock was low.
  • The stock sank, but not to the BE.
  • The put premium was high on a strike that was well below my BE that selling that made my BE even lower.
  • Now of course the call will probably expire worthless and my BE is quite a bit lower than it started out and more than 40% below the put strike
  • The stock would have to lose more than half it's value for me to lose anything on the original purchase.
  • I have yet to see a loss on the stock and I've collected two premiums.
However, the large premium blinded me to the fact that I may have to buy more of the stock if the stock reaches the put strike. That's still a 15% drop a way.

So two outcomes:

  • I may get to Mar 17th with two premiums, low basis on the stock, and a lesson
  • I get to Mar 17th with two premiums, twice as much stock than I planned on (hopefully worth more than the bid), and a lesson.
I wouldn't call that f***d, but still a beginner's mistake. I'll report back with the results on exit.
 
looking for stock with the highest premiums in order to collect "free profits" is a terrible strategy. High premiums means high risk. There is no such thing as a free lunch. The premiums are high because traders know the stock has issues.

Anyways now you are double long on whatever stock. My advice, stick to SPY and/or IWM in differing ratios depending on your time horizon.
 
If you aren't extremely bearish on the underlying, and don't mind holding it for a bit, here's how I would deal with that situation to mitigate my loss, or eventually wipe it out:

- For the short covered calls, I would keep the stock, and either roll the short calls down to a lower strike in the same month to collect more premium, or wait for the current calls to expire, and then continue to sell further out covered calls to continue collecting more premium until the shares are called away.

- For the short puts, if I didn't want to get assigned, I would see if I could roll them out another month and the strike down as much as you can (a diagonal) for a wash or small credit or small debit.

These actions work well with my strategies because I don't take very large positions in any one particular underlying, relative to the size of my whole portfolio. (I also mostly use underlyings that I don't mind "bag-holding" for a longer term investment, so I don't generally feel any heat to get out of a position quickly.)

Good Luck.
 
Ryan81,

Good ideas. I'm green still, but I was thinking along these lines as well and I like your ideas. Basically: keep rolling out to strikes or dates on both legs as much as possible to keep the premiums coming in. This probably would not be worth it were the IV not high (over 200%). I'll analyze and see if I should adjust on Monday.

Thanks again.
 
Ryan81 said:
If you aren't extremely bearish on the underlying, and don't mind holding it for a bit, here's how I would deal with that situation to mitigate my loss, or eventually wipe it out:

- For the short covered calls, I would keep the stock, and either roll the short calls down to a lower strike in the same month to collect more premium, or wait for the current calls to expire, and then continue to sell further out covered calls to continue collecting more premium until the shares are called away.

- For the short puts, if I didn't want to get assigned, I would see if I could roll them out another month and the strike down as much as you can (a diagonal) for a wash or small credit or small debit.

These actions work well with my strategies because I don't take very large positions in any one particular underlying, relative to the size of my whole portfolio. (I also mostly use underlyings that I don't mind "bag-holding" for a longer term investment, so I don't generally feel any heat to get out of a position quickly.)

Good Luck.
More...

The only thing that you need to be careful about is that if the stock drops so low to the point that there is no calls that you can write that will allow you to sell the stock at a profit if it's called away, then perhaps it's time you consider buying a put and exercise it to sell it at a profit hopefully or sell it at a loss if the put has become too expensive by that time. There is no point keeping the stock any further unless you still want to wait it out to see if there is a chance that the price will go back up. Hopefully you have collected enough premiums that it will well cover the cost of the put.

In the future, just remember selling the put is when you want to get the stock without paying the full price for it and you are only going to get the stock when the price is tanking but you are extremely confident that the price will bounce right back up shortly.

And another thing to remember is that you should only short strangles when you expect the volatility is NOT going to be big because when you are writing options, the key is to collect premiums and let the options expire worthless and NOT to get assigned. Once you are assigned, you are screwed. In a strangle, you are selling a put and a call between two strikes so the price of the underlying stock can only move in between those two strikes in order for you not to get assigned. So the volatility has to be small for the price not to move too much. Once the volatility becomes large and the price moves to either direction too much you are going to face the risk of getting assigned unless you incur a loss closing the position.

Overall I agree with Ryan81. His strategies are good.
 
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