So is a long OTM call a rational thing to do if you want to write calls for income? The "conventional wisdom" that I've seen says you should buy ATM or DITM LEAPS and do calendars or diagonals. Writing naked calls would be OK except for that pesky upside problem. Wouldn't an OTM long call cover that, and be cheaper? You can protect against being assigned by rolling up and out before the short leg expires.
Newbie Question: Married Puts aka Covered Puts
- Thread starter Stoxtrader
- Start date
Writing short term CALLs on DITM LEAPS is similar to the traditional covered CALL (naked PUT) strategy that everyone knows well.
Writing short term CALLs on long OTM LEAPS is a different variety of diagonal.
You can think of it as a long calendar + a short vertical. The credit from the vertical offsetting some of the debit from the calendar but with a comensurate increase in risk to the position (the long CALL doesn't entirely cover the short CALL - the bigger the gap, the bigger the risk). This will be reflected in margin requirements. So, although the reduction in initial cash outlay over the traditional covered call looks appealing, it comes with potential drawbacks.
This long diagonal (short closer to the money near term CALL + long OTM long term CALL) is dominated by the calendar component and is therefore long VEGA.
The position as described above is actually also ratioed, such that there are more long term CALLs than near term short CALLs. This increases the VEGA sensitivity of the position.
It is essentially a calendarized CALL backspread.
You want to have an expectation that volatility is going to increase.
The problem is that as the underlying rises to the short strike, implied volatility is likely to drop, hurting the value of the LEAPs.
The position will be short GAMMA and long THETA thanks to the near term short options and thus an income stream is feasible.
In addition, the position makes most money at each expiration if the underlying is at the strike price of the short near term CALL. This is behavior you will recognize from standard long calendars.
In order to properly manage the position as the underlying fluctuates and possibly moves far away from the short strike, it is advisable to be familiar with the management of multi-month calendars.
For understanding the risk in the position, again, be familar with standard calendars and also look at the risk in the embedded short vertical.
As has now been well established, all of the above is equally valid if married PUTs are utilized instead of a long CALLs.
Apologies if I have repeated what has already been discussed on this position.
Good luck.
MoMoney.
Quote from FullyArticulate:
This I did not know. A friend of mine has some stock he's kept for years as an unrealized gain (he doesn't elect mark-to-market). He writes calls against it and generally keeps the profit on expiration without affecting the tax status of the underlying. At the same time, he'll generally just buy back the calls at a loss if the stock rallies hard. He's obviously not writing ITM calls, as you described, so maybe the situation is different.
I'm no tax expert, and if the group has a hard enough time agreeing on put/call parity, I don't want to open the "tax code interpretation" thread which is sure to be filled with diametrically opposed positions which are all correct. In any case, something worth investigating.
This excerpt from this site would seem to say the opposite of what I thought:
if you write (grant) a call or a put, do not include the amount you receive for writing it in your income at the time of receipt. Carry it in a deferred account until:
1. Your obligation expires,
2. You sell, in the case of a call, or buy, in the case of a put, the underlying stock when the option is exercised, or
3. You engage in a closing transaction.
If your obligation expires, the amount you received for writing the call or put is short-term capital gain.
If a call you write is exercised and you sell the underlying stock, increase your amount realized on the sale of the stock by the amount you received for the call when figuring your gain or loss. The gain or loss is long term or short term depending on your holding period of the stock.
If a put you write is exercised and you buy the underlying stock, decrease your basis in the stock by the amount you received for the put. Your holding period for the stock begins on the date you buy it, not on the date you wrote the put.
If you enter into a closing transaction by paying an amount equal to the value of the call or put at the time of the payment, the difference between the amount you pay and the amount you receive for the call or put is a short-term capital gain or loss.
Thanks.
Holy cow! A person who does actual RESEARCH and reports back! If there were more like you here on ET, we'd live in a much better world.
(Or maybe that should be, if we lived in a better world, there'd be more like you here on ET)Quote from FullyArticulate:
Holy cow! A person who does actual RESEARCH and reports back! If there were more like you here on ET, we'd live in a much better world.
OK, now to totally confuse you, I found the original reference I posted first. This is from "New Insights on Covered Call Writing" by Lehman and McMillan, appendix C. I'll just summarize:
For OTM covered calls - no effect.
For "qualified ITM calls" - the holding period is suspended while the call is in place.
For "non-qualified calls" - if the holding period of the stock is not yet long term, then it is eliminated entirely while the call is in place [kind of ambiguous - EH]. If the holding period is already long term then there is no effect.
Qualified is first or second strike ITM, depending on stock price and some other factors.
Non-qualified is deeper ITM.
Basically I think if you intend to unload the stock by writing DITM calls then you can lose long term holding status.
Hope this helps
BTW, Lehman and McMillan have some other tax advice is the book that is suspect. I'd go to a CPA who knows options to get a better understanding.
Whether our diagonal example is called long or short gets us into option terminology purgatory. As a combination of a short vertical and long calendar, there seems to be no middle linguistic ground. You can focus on one of the greeks to pick the long or short description as long as we all know which one. I was not relying on a particular greek but on the usual diagonal construction which evolved from the long vertical debit spread so was coming from that framework where a short-term OTM option is sold against a far month ATM. Such would be described as a "long" as in diagonal Leap spreads. In our situation where a short-term OTM (Nov 85 call) is sold against a long-term further OTM (April07 100 call), I suppose you could call that "long" as you and MoMoney do as long as you tell us why.
I would also be interested in hearing why you think this is a "worthless bet".
Thanks for the clue and yes I did read that, but I asked for an explanation, not just an opinion.Quote from rallymode:I think you are the one not reading this time. Clue: Late night entertainment.
Despite what the puerile upstart wise-a** has to say, we are all here to learn. Sometimes people skip to their bottom-line opinions while the rest of us might appreciate seeing how you got there.
Here is what you wrote: "This whole idea to pay for the time value in 3-4 months and end up owning the intrinsic between the spot and the put for free is just ridiculous and best suited for late night entertainment." I understand that is your opinion and you not likely to change it, but is too much to ask how you got to that assessment?