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Covered calls are popular among investors looking for a conservative way to generate additional income from their stock holdings. However, it's essential to understand both the benefits and risks before implementing this strategy. Example of a Covered Call: Long Position: You own 100 shares of XYZ stock, currently trading at $50 per share. Sell Call Option: You sell a call option with a strike price of $55 for a premium of $2 per share. Outcomes: Stock Price Below $55: The call option expires worthless, you keep the premium, and you still own the shares. Stock Price Above $55: The call option is exercised, you sell your shares at $55, keep the premium, and realize a profit from the stock's appreciation plus the premium received. Understanding Greeks and Covered Calls If this is your first parlay into covered calls, you also need to familiarize yourself with options Greeks. Options Greeks are key metrics used to understand the behavior of options prices. They measure various risks and sensitivities in an options position. When using covered calls, understanding the Greeks can help investors make informed investing decisions. Delta Delta measures the sensitivity of an option's price to a $1 change in the underlying asset's price. For a covered call, the delta of the call option is positive but less than 1. This means if the stock price increases by $1, the call option’s price will increase by an amount less than $1. As a result, the covered call position (long stock and short call) will experience a partial offset of gains in the stock by the losses in the short call. Gamma Gamma measures the rate of change of delta with respect to changes in the underlying asset’s price. Gamma is the highest for at-the-money options. For covered calls, a lower gamma (typical of deep in-the-money or out-of-the-money calls) indicates less sensitivity to price changes in the underlying stock. This means the delta of the option will not change as dramatically with price movements. Theta Theta measures the sensitivity of the option’s price to the passage of time (time decay). Theta is particularly important for covered call writers because it represents the premium decay over time. As the option approaches expiration, its value decreases, benefiting the seller. For covered calls, a higher theta means the option loses value faster, which is advantageous to the call writer. Vega Vega measures the sensitivity of the option’s price to changes in the volatility of the underlying asset. Vega is important because it indicates how much the option price will change with a 1% change in implied volatility. For covered call writers, a decrease in volatility after selling the call is beneficial as it reduces the option’s price, making it more likely to expire worthless. Practical Application in Covered Calls 1. Selecting Strike Prices: Understanding delta can help in choosing the right strike price. Higher delta options (in-the-money) have a higher chance of being exercised, while lower delta options (out-of-the-money) have a lower premium but less likelihood of being exercised. 2. Timing and Expiration: Theta helps investors decide the optimal expiration date. Shorter-term options decay faster, benefiting the call writer due to higher time decay. 3. Market Volatility: By monitoring vega, investors can choose to write covered calls when volatility is high to capture higher premiums while being aware of the risks associated with potential volatility decreases. Example Scenario: Stock Position: You own 100 shares of XYZ stock, trading at $50. Option Selection: You sell a one-month call option with a strike price of $55. Delta: The option has a delta of 0.30, meaning the option price will increase by $0.30 for every $1 increase in stock price. Theta: The option's theta is -0.05, indicating it will lose $0.05 per day. Vega: The option has a vega of 0.10, so for each 1% decrease in volatility, the option price drops by $0.10. Understanding the Greeks provides a comprehensive view of the risks and potential rewards associated with covered calls. Who Should Use Covered Calls? Income-oriented Investors: Those looking for additional income streams, such as retirees, may find covered calls appealing. The premiums received from selling call options provide a regular income, which can be especially useful for those relying on investment income. Long Term Existing Stockholders: Investors who already hold a substantial position in a stock and do not plan to sell it soon can use covered calls to generate income. This allows them to monetize their holdings without liquidating their positions. PROs of Covered Calls Income Generation: You earn the premium from selling the call options, providing additional income. Downside Protection: The premium received can offset some of the losses if the stock price declines. Selling at a Target Price: If the stock price rises and the call options are exercised, you sell your shares at the strike price, which is usually higher than the current price when the options were sold. CONs of Covered Calls Limited Upside: Your potential profit is capped at the strike price of the call options sold. If the stock price soars, you won't benefit beyond the strike price. Obligation to Sell: If the stock price exceeds the strike price, you may be obligated to sell your shares at the lower strike price. Stock Decline: While the premium offers some protection, it doesn't eliminate the risk of a significant decline in the stock price. The Bottom Line Covered calls are a conservative strategy that helps investors generate additional income from their stock holdings. By selling call options on stocks you already own, you can earn premiums while maintaining a measure of downside protection. This strategy is best suited for income-oriented and conservative investors who anticipate stable or moderately rising markets. However, it comes with the trade-off of capped upside potential and the obligation to sell shares if the stock price exceeds the strike price. Understanding the key options Greeks (delta, gamma, theta, vega) can further optimize the use of covered calls for effective risk and reward management. Post by Adam Koprucki
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i am a new steadyyields member. having watched for 1 month, where is the appropriate place to ask questions. i,,m new to this strategy but not to trading IC, CS,or DS
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Thanks for looking into the @Djtux. I am part of a discord group that says you cannot use the IV numbers from VolHQ so I am trying to confirm if what they are saying is accurate. Here is what I see for Monday Feb. 26, 2024 EOD (T-2) Also, if T-2 is Monday then the x-axis and label is shifted wrong because it shows T-2 as Friday. Can VolHQ adjust automatically based on earnings being EOD or BMO?
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T-0 would be Wednesday. T-1 Tuesday EOD. T-2 would be Monday EOD. Can you check what ONE give for monday EOD ?
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@Djtux I am looking at IV for CRM which seems to show IV at 102 on the Friday before the Feb. 28 earnings which would be Friday Feb. 23. However, I don't see any IV higher than 68 even near the close on that Friday as shown below: I am trying to figure out why the VolHQ IV numbers are so different from ONE and TOS historical data for that Friday before earnings. In the past I had messed up with the trading days (T-X dates) but because this is a Wed. AMC release same as in Feb. I think the x-axis is not correct somehow. This is not the first time I have seen this so I am trying to make sure I am reading the charts correctly or if there is a global error somewhere. Thank you.
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Thank for the insights @Yowster It's not a typical SO trade. t's more like a lotto, given the contradictory signs.
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My thoughts on AMAT straddle: Regarding the IV, of course it will have a large spike because earnings day is only one day from expiration. But because RV decreases a majority of cycles, the IV increase doesn't fully compensate for the negative theta in those cycles. Looking back over the last 3 years, RV drops 3 out of every 4 cycles. The rising cycles tend to be larger spikes, so if you are in a straddle on those cycles you'll see a nice gain. There are also a few cycles where the stock price had a larger move over the last 2 days and these were nice winners. In summary, an AMAT strangle has more downside risk than those we typically use because losses of over 10% happen more often when RV drops and stock price doesn't move. But, when RV rises it tends to be a larger rise and stock price had some decent stock price moves so if you hit a cycle like that you can see a nice sized gain.
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Thank you for the help and the explanations., @TrustyJules Much appreciated
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IV has value but RV encompasses both and so is often more useful - nevertheless you cant completely ignore it because if its low (historically) and some event might make it move you could get more oomph out of your IV than otherwise. People vary in the importance they attach to it - I find it still relevant but check RV to mitigate being too optimistic. The stratospheric rise of IV before earnings is after all partially an outcome of the fact that IV is a basket to catch what the mathematical models cannot (earnings). @Christof+ always points this out and he is right. With RV over average and decline strong I find it less compelling - the second point about the outsized return however doesnt concern me so much. Its more important to see how many losers there are and how big they were. If they are low and we could be in line for a 75% one every 10 times we do this then it could be well worth it.
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@TrustyJules, Thank you. So, if I understand correctly this IV indicator doesn't have any value in this analysis. Given this and the fact that you pointed that RV is currently above average, we don't have a case for make a AMAT straddle. Correct? Also looking at the historical results, I noticed an outsized value of 75%. Without this value the average would be much lower (around 7%). This is also a negative point. Do you agree?
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The analysis is not bad HOWEVER: 1) Note that RV encompasses both IV and theta changes as well as market movement - the rise in IV is therefore included in it and you cannot count it as a separate point in favour; 2) Current RV is above average which combined with the strong decline in RV means that there is a lot to make up
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AMAT has the ER scheduled to May/16 AMC. Today (May/14) is T-2 As an exercise I looked at it as a potential candidate to two day straddle. I present bellow what I could understand from VolatilityHQ data. Would you please comment on my interpretation and conclusion? Please keep in mind that I am in the learning process on interpreting these charts. Thanks in Advance. RV falls in 6 of the 8n cycles. On average falls 9% The stock doesn't seem to move much (exception for two of the cycles) Straddle IV more than doubles AMAT returns on average 15.42% on this trade. Five of eight cycles return positive. Biggest loss is near 13% My conclusion: The fact that RV usually goes down and the stock doesn't move much makes this stock a bad candidate to a T-2 straddle. However the big jump in IV and the fact that the result is historically positive makes me think that it could be a good candidate. Given these data I would enter the trade.
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I wasnt saying to combine the two strategies - but one can. There are other ways to neutralise some of the delta too. The time to expiry plays a role in what is best, I was just giving you some options.
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The best you can do is backtest your trade plan across different market regimes, to see how it behaved and get a feel for it, manage your expectations, and build confidence. OptionNet Explorer is great for this. The values of the greeks may be different, but the P&L is not.
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Thanks a lot! I get your point. Basically you mean to roll the losing Short (Credit) Call Spread to an higher Strike, same Expiration for a net debit and additionally buy (as a hedge) Long ATM Calls, 1 month further. If XYZ rises then these Long ATM Calls will generate some profit. And to compensate this additional investment roll the Put (Credit) Spread to a higher Strike. Maybe the whole new setup will be for not a big net debit. I’ll try this.
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What you describe is not hegding but digging the hole deeper and exposing yourself to more losses. If you are looking to role the expiry of your IC itself then you are effectively taking a new position with additional losses possible. Not something I recommend. My example is, STOCK XYZ @ 100 and you have an IC: 10 SHORT PUTS XYZ June 21 60 10 LONG PUTS XYZ June 21 50 10 SHORT CALLS XYZ June 21 100 10 LONG CALLS XYZ June 21 110 So your call side is obviously challenged - buy 1 month out or further a call 1 CALL XYZ July 19 100. The reason to be ATM and a month out is to have maximum delta effect and still not lose too much to theta if the stock retreats as was your original expectation. If XYZ continues to advance then your hedge will help against the loss - mind that if the call delta rises too much more drastic measures are needed like moving the whole operation a strike or so up. In the above scenario if you are lucky you might for no cash outlay be able to get to: 10 SHORT PUTS XYZ June 21 80 10 LONG PUTS XYZ June 21 90 10 SHORT CALLS XYZ June 21 105 10 LONG CALLS XYZ June 21 115 Always mind that you want the shorts delta to be below 30 certainly if you are getting close to expiry - which is not quite the case above.
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1. "buy an option a month out ATM in the direction of the challenged side (put or call as the case may be)". Yes, I do this, maybe not a month out but 2-3 weeks out. 2."Try and neutralize some or all of the delta and once the crisis passes sell your hedge option and wait for your IC to bring home the bacon (premium)". Can you please elaborate a bit what you meant if for example my Call side is now being tested? I have moved my Puts ( untested side) down to earn some extra premium, same expiration and around the date of expiration I want to roll over my tested Call side to a further expiration, OTM strike for a debit and to compensate this loss sell equal number of Put OTM spreads, same expiration. But overall this will generate a loss, although not a big one. Thanks.
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@Bullfighter Thank you for your reply. I think you are right; a lot of these tools make assumptions and those assumptions can wildly affect the results. I had not given as much thought to how IV affects outputs and assumed that they didn't have as wide as an effect as they evidently do. I will try to factor that in to my investments, although I do not know quite how since the actual IV in the future changes. Complicated!
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@TrustyJules Thank you so much for your explanation! First off, I am sorry that I forgot to post the strike prices ! 😳 Yes, you assumed them correctly. I did take the midpoints as you suggested when I posted the results earlier. I note that OptionsProfitCalculator and Options Strat are virtually identical, so I am assuming that they use very similar algorithms. Your explanation in the first paragraph makes sense even though at first I got nowhere near the $278 max that your model did. It defaults to buying at market prices but you can input whatever you want to be more accurate for your trade, which I did. I chose the midpoints. It got very close to your number: $270.95. So I think these two tools are probably pretty accurate (as can be) given the right inputs (the actual price paid for the two legs and not market, as well as the correct IV assumption...which is essentially an educated guess). While playing around with Options Strat there is a IV bar you can slide. I see how much IV affects the results. A lot. ETrade is another story. They have two tools (the basic one and the "Power ETrade" one) that give wildly different results. This is alarming. Power ETrade and it has a slider for submitting different positions at a certain price. It takes the cumulative of the position so you do not get to specify one of the legs exactly. It could be that one of the legs was higher than the midpoint and the other lower...but it results in the same value. I buy at the midpoint most often. The basic ETrade tool allows you to choose "debit", "even" or "credit". I am assuming that this means "bid mid ask". I suspect if I play with the IV and make sure that the buy/sell prices are accurate then these tools will be more accurate too. Maybe. But one thing I learned is that there are a LOT of assumptions in these tools and things like IV can be guessed at but not definitively known in the future. By the way, how do they calculate IV? Is it a six month in arrear running average or something? Right now I just have to accept the numbers given. I can't really ascertain what a recent large drop or large gain has done to it. Thank you so much for your very detailed explanation!
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I'm having email issues again today. Started out as 10~20m delays, then they stopped all together. Anybody else?
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Thanks a lot for your advice!
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The discipline to exit at your pre-determined loss levels, in my humble opinion, is the best way to have repeatable long-term trading history that is positive. It's not sexy, but "managing" a trade often involes both an increase in risk and capital to mitigate a loss. Your asking about Iron Condors, so I will give general thoughts for management. 1) close the opposite short if there is little credit 2) Is there intraday support/resistance at where the short put/call that is being tested? If you are confident in the intraday support/resistance then you can consider rolling up/down the short put/call farther into the money, and/or rolling the long put farther out of the money. Your new thesis of this trade is you are now betting the trade WILL BOUNCE off this support/resitance to mitigate your loss. UNDERSTAND you have INCREASED your max loss by NEW WIDTH of the wing of the condor. DO NOT BE GREEDY if you get your bounce. EXIT if it back trades halfway in the current day swing your are hoping happens. You are trying to ideally get a smaller loss, break even, or maybe a small gain. Most often, just a smaller loss. 3) If your support or resitance breaks, exit immediately realizing that you turned a 5-7% loss into a 10-20% loss, and you would probably loose less at a blackjack table over time lol. But exit immediately, and very seriously. This is just general. Time in trade, and to expiration matters. I stand by my first comment just to exit early at your pre-determine loss and move on as the best long term stragety.
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It depends on the length of time to expiry - there is a lot that can be done on solving IC positions as long as there is still time. The silent killer of ICs is gamma - a greek mostly overlooked but which will rip your IC position to threads in minutes if you are less than a week from expiry. In such a case perhaps best to close - suck up the loss and move on. When a short side is only challenged a few possibilities exist: - buy an option a month out ATM in the direction of the challenged side (put or call as the case may be). You can do so in a lesser ratio than the amount of ICs you have open - how many depends a bit on delta of your challenged position. Try and neutralise some or all of the delta and once the crisis passes sell your hedge option and wait for your IC to bring home the bacon (premium). - if you move the position - move as far as you can whilst still remaining near 0% profitability - half measures dont help and you will be able to move only inches for every yard you give on the unchallenged side. Look carefully at option calculators to determine the chance of your short or break-even being breached and move as far as you can from that.
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There are several reasons why you get different values: One is that there are several options models. As in any field, they are not reality, or 100% accurate. These calculators may be using different models. Another is that you are using different expirations. When doing that, the expiration like is not fixed: it can move up or down depending on the relative values of the front and back expiration legs. The calculators may be using different assumptions on the relative changes of implied volatility for the legs. One of those assumptions is no IV change on any leg. The truth is, nobody knows what the market reaction is going to be. All you can do is make an assumption.
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Can I ask a question here? It’s a good topic. TrustyJules, I would appreciate your inputs on how to manage a losing Call/ Put Spread? When the Short side is tested. This is specially true for weekly Iron Condors . I couldn’t find anything in the Educational section of SO. Thanks!
