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Newbie question on income by selling calls
- Thread starter Neutral
- Start date
But its extrinsic value is zero. And any intrinsic value would be covered by the stock bought right at the strike price or slightly below (right before it hits the strike price). I am a newbie, but I think I am right about this.Quote from gkishot:
call option is not 0 if the stock price is above it's strike price at expiration.
Quote from Neutral:
But its extrinsic value is zero. And any intrinsic value would be covered by the stock bought right at the strike price or slightly below (right before it hits the strike price). I am a newbie, but I think I am right about this.
If you're trying to achieve income by selling call options you won't get any if stock advances above the strike price.
That's fine. But you didn't explain why. Could you explain the mechanics of why that should be the case? Doesn't it depend on how much time decay has taken place between the time one sells the call and the strike is hit? Granted, if the stock jumps up the next minute you sell the call, no amount of delta hedging will keep you from losing money, if not the whole premium, then a whole lot of slippage and commissions trying to delta-hedge all the way to expiration. Do you mean you can't derive income from selling options without betting right on direction on average? Because an occasional loss doesn't necessarily mean "you can't derive income from selling options".Quote from gkishot:
If you're trying to achieve income by selling call options you won't get any if stock advances above the strike price.
Anyway, could you please explain your statement in more detail?
Quote from Neutral:
Well, if I am buying purely to hedge, I would have to look at the delta, which would have to be around 0.50, meaning 50 shares for each option. But the spirit of the question was more along the lines of "I will just buy the darn shares at the promised price and get ready to deliver them", which would mean full 100 shares per option. Presumably, if the stock runs from 550 to 590, it would take a while (so close to expiration date), and have a reasonable momentum, mitigating the downside risk. But then, I don't know much.
Your main risk then is that the stock moves strongly up and hits the 590 strike, the point where you say you will buy the stock. At this point, you have a covered call position with ATM call options that you sold for probably much less than it's worth now. The whole risk now is to the downside, and there's a lot of downside, so how do you plan to protect yourself?
Another risk is the gap risk. If GOOG moves up and closes slightly below 590 and then gaps up a lot, you might buy GOOG stock at a price higher than 590 with the buy stop order.
Yeah, that part I already thought about. One would have to dabble in "well-behaved" stocks. Biotech, for example, would be a bad choice, I think. Thanks for your answer.Quote from Premium:
Your main risk then is that the stock moves strongly up and hits the 590 strike, the point where you say you will buy the stock. At this point, you have a covered call position with ATM call options that you sold for probably much less than it's worth now. The whole risk now is to the downside, and there's a lot of downside, so how do you plan to protect yourself?
Another risk is the gap risk. If GOOG moves up and closes slightly below 590 and then gaps up a lot, you might buy GOOG stock at a price higher than 590 with the buy stop order.
I just don't understand the concept of hedging a trade like this.
You should always be able to ask yourself "If I was flat, would I enter into this position?" If the answer is Yes, stay in. If the answer is No, get out.
Another way to think about it is, Would you invest more in the position if you spontaneously had more money in your account?
Let's say you sell your option at $10 because you think you have an edge and you're odds say you're going to make money. Oops price moved against you, now your option is $1. Your rich aunt dies, so sad, but she left you $100. Would you sell another option at $1? I think you would say Oh hell no, price has already moved against me. Then WTF are you doing in the position?!?
How many times have I heard someone say "I got in at $10 then it went to $20 and now it's back down to $10. If I didn't already own it, I would never buy it."
If you don't get it, well, I'm not going to tell you. I don't tell my Aunt Cathy to sell either. She isn't looking for investment advice, she's just making conversation and looking for a shoulder to cry on.
You should always be able to ask yourself "If I was flat, would I enter into this position?" If the answer is Yes, stay in. If the answer is No, get out.
Another way to think about it is, Would you invest more in the position if you spontaneously had more money in your account?
Let's say you sell your option at $10 because you think you have an edge and you're odds say you're going to make money. Oops price moved against you, now your option is $1. Your rich aunt dies, so sad, but she left you $100. Would you sell another option at $1? I think you would say Oh hell no, price has already moved against me. Then WTF are you doing in the position?!?
How many times have I heard someone say "I got in at $10 then it went to $20 and now it's back down to $10. If I didn't already own it, I would never buy it."
If you don't get it, well, I'm not going to tell you. I don't tell my Aunt Cathy to sell either. She isn't looking for investment advice, she's just making conversation and looking for a shoulder to cry on.
Yes, you keep the premium, but in the above scenario you will be selling your delta at the same or lower price than you bought it. So you will, at best, spend your premium on commissions.Quote from Neutral:
So, to me, the take-home message (for trying to make money from selling OTM calls) seems to be:
If the price approaches the strike close to the expiration, start buying the underlying according to current delta, and buy the whole 100 shares if the price strikes, and endure the 0.5 delta risk for the remainder of the expiration (say a day or two). Hopefully the shares don't turn around and plunges like a rock right before assignment. If the stock turns around, reverse sell back in the same rate as on the way up. If all goes well, I keep the premium, minus the commissions, and maybe a bit of stock appreciation.
It makes no difference how high the premium goes as long as the stock is bought at the strike (1 round lot per naked call) - the income sought will be attained. Breakeven is strike plus premium so one can buy the stock up to $194.40Quote from gkishot:
There is no income if the stock advances because the options would actually lose money.
If stock is bot below 190, the gain will be larger, if assigned.
Quote from Neutral:
You are probably an experienced options trader, and I am sure it works for you, and hopefully for me some day soon. But my concern was more pedestrian, namely, as a newbie, am I missing anything other than the downside risk in the shares I buy at the strike price for the purpose of delivering them.
Nope, not missing anything if that's all you're looking at
Now, I am assuming that this will happen very close to the expiration. If not, I understand that I need to delta-hedge. I have read that perfect delta hedging is a zero-expectation activity, and the transaction costs, as well as the finite steps, make it negative. Better than having my head handed to me to be sure, but I am not very enthusiastic about delta-hedging as I was earlier. I still have a ton to learn.
If you think it's going to rise closer to expiration, wait until it happens and sell a higher strike. Reality is, we have no clue what will happen on what date. Ever hear of penny wise and pound foolish? The "negative expectation" is far less a problem than the head handing a naked option could hand you. If you don't understand the the trade and you don't know in advance how to manage it, don't do the trade ... or stick to spreads which are a lot safer.
But I suspect that experienced traders make their money from directional bets (including no-direction) as well as spotting price anomalies. Those, and especially spotting options price anomalies are beyond my grasp at the moment. As for gamma-scalping, I need to learn more about it before I can begin to comment on it.
IMO, experience traders make money taking higher probability trades and managing the risk with huge emphasis on the latter. Forget about price anomalies.
So, to me, the take-home message (for trying to make money from selling OTM calls) seems to be: If the price approaches the strike close to the expiration, start buying the underlying according to current delta, and buy the whole 100 shares if the price strikes, and endure the 0.5 delta risk for the remainder of the expiration (say a day or two). Hopefully the shares don't turn around and plunges like a rock right before assignment. If the stock turns around, reverse sell back in the same rate as on the way up. If all goes well, I keep the premium, minus the commissions, and maybe a bit of stock appreciation. If the price approaches the strike early, with many days/weeks left to expiration, try to delta hedge, with a view to minimize losses, but expect to lose some money.
Well, sort of. Delta drops as time passes and rises as price increases. The latter is your larger problem. Right now you're around 20 delta. Buying 100 shares at the strike flips you from -50 delta to + 50 delta and reverses your risk. No problem as long as that's where you want to be.
If you buy shares at 30 or 40 delta, you're raising your break even since at 50 delta (the strike), they'll have a capital gain.
I disagree that you should expect to lose money if the stock approaches the strike early and you try to delta hedge. Losses will occur if you are short delta above the upside breakeven or long delta and it reverses to the downside. If it diddles around in a range, you're going to make money.