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If and when it is ever available for public knowledge, I would love to see your call selector.

It's not likely to happen, here is why but first a bit of history.

Early on I avoided options because they are complicated and confusing. A good part of Warren Buffett's success is using other people's money (OPM) for free, first as a fund manager, later through B-H, insurance float, etc. How does an ordinary Joe get to use OPM? Selling options!

Selling puts is exactly the same as selling any other kind of insurance. If you do it right you make money. The problem with puts is that you might have to buy shares -- spend money -- when you are short on cash and you have no control over it, you lost that control when you sold the puts. I started selling puts in December 2008 and did very well in the run up from the bottom but the lack of control soon took a bite. Selling puts is just like being in debt.

Selling covered calls does not have that problem, if the option holder wants your shares, he has to pay up. There never is a liquidity problem. The risk is opportunity loss if the price goes above the strike price. If the price goes down you are better off having sold the calls because you got cash from them -- your cost basis is lower. This is the basis of my selling covered calls, collect OPM and never have a liquidity issue.

Execution is complicated, a lot more complicated.

- You have to find the right shares
- You have to find the right options (expiration date and strike price)
- The premium is not some simple function because it is based on discrete data (expiration and strike price) in addition to fast moving data (stock price and volatility)
- The premium itself is not enough to go on, you have to balance it against being called to minimize opportunity loss

Initially I was doing the calculations with a spreadsheet and on a stock by stock basis, while cumbersome, it works. The drawback is that it does not tell you if this is the best stock to sell calls on. If you have a universe of ten stocks to work with, you need something better, something faster. That's the reason for the Covered Call Selector as a web-app. Since I don't have access to live option chain data I download the option chains when the market is closed. I'm still working on the page that compares the calls on various stocks. I haven't done any coding since I left home.

A funny thing happened using the Covered Call Selector! While some of my intuitions proved correct I got some surprises. Initially I thought some stocks were better for covered calls than others. While true, because pricing is based on discrete data, stocks are not uniformly good or bad for selling calls, it depends a lot on where stock price is in relation to strike price and to recent volatility. At my point on the voyage of life I'm not building an egg's nest, I'm harvesting cash to pay for expenses. As a consequence, a stock that is not now good for selling calls needs to be replaced by one that is. I've become a trader!

Another revelation is that fast growers are the best candidates for selling covered calls. This should not come as a surprise because the higher the growth rate, the higher the volatility, the higher the premium. As a consequence I have sold my solid but slower growers (BEAT, ODFL, V).

Selection parameters

CAGR is very good when comparing investments over longer time frames, a year or more, but quite useless with short time frames typical of time to expiration. I've come up with a much better metric, "Dollars per Day" (DPD). Suppose you need $36,000 a year to live on. Divide by 365 and you need the portfolio to throw off $100 per day. $72,000 = $200 per day.

Here is a real world example: Three weeks ago the selector picked APPF May 17 calls, strike $100.

May 1 - Bought 100 shares at $96.31, sold a call for $3.30
May 3 - APPF crashed, bought back the call for $0.75
May 6 - APPF recovered a bit, sold a 95 May 17 call for $2.90
May 13 - APPF crashed again, bought back the call for $0.85
May 17 - APPF recovered but the selector said there were no good calls, sold at $97.50

Result, made $6.11 DPD on price appreciation, $24.55 DPD on option premiums for a total $30.66 DPD over 17 days.

Today the selector says to sell $115 May 31 calls on OKTA which closed Friday at 110.94, premium $34.21 DPD, if called, $32.21 DPD for a total $66.42 DPD over 11 days.

How is it working out? The time is too short to tell for sure but the portfolio is doing better than before, beating NASDAQ YTD. BTW, since calls go opposite stock price, the portfolio is less volatile.

Next post will be about making the selector available.

Denny Schlesinger
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It's not likely to happen, here is why but first a bit of history.

I think you are responding to me from Long ago or maybe somebody more recent but thanks for considering. Most of my options are to sell covered calls in my IRA to raise additional investment funds. On occasion I have had share called though often with the chance to get in below the call price. SHOP was the exception, around $105 I believe and I bought back in around $115.

I only ever bought LEAPS before but should consider selling Puts on companies I may want to own but I just buy the shares then.
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Denny,

Thanks for sharing this. I had been wanting to ask for some details on your selector for some time now.

I have a portion of my portfolio set aside for options trading. I target 1% per month returns from the premiums. I have had mixed results, with the poor side of returns caused by my selection of stocks.

I use a mix of options including puts and calls, spreads, diagonals and the like. I like the simplicity of puts, and I always ensure I have the funds available to purchase the underlying if assigned. Not much different in function than a covered call but lower transaction fees if all goes well.

The biggest fails I’ve had, are when one of the more volatile stocks takes a huge dive and doesn’t recover in a timely manner. NVDA is one example. So, whether I would have written a covered call or have a cash backed written put, my loss is pretty much the same. I end up with a stock that’s worth considerably less than I paid for it. And, those nice premiums I was receiving seem quite meaningless given the magnitude of value reduction in the underlying.

So, gets back to my interest in what you are doing and how you handle your stock selections, or how you handle a big drop in value of the underlying. Do you not have that happen because of superior stock selections? Or do you get out if you see a problem with earnings, etc and take your losses quickly to mitigate more of them? Or, do you sit and wait without writing calls if there isn’t a fundamental company problem, essentially eliminating the income stream until a future date? Or, do you continue writing calls, hoping that the stock price doesn’t run away from you resulting in the stock getting called away, locking in a loss? Maybe a combination of those actions. I’ve tried them all when I’ve had a problem with an underlying and have mixed results.

I know I embedded several questions there, and really, my main question is about mitigating against a big drop in value with the underlying position, especially when you are targeting high premium, highly volatile positions.

Thanks much,

Paul
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'May 3 - APPF crashed, bought back the call for $0.75'

Do you have a rule of thumb for when to buy to close, Denny? I've heard 80%?
P
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I look to see Denny's reply when it comes.

I'm sure you know the "down and out" technique of replacing a near dated deep in the money put (from a misbehaving put sale) with a less deep sale with greater time value.

I've used it any times, I had to carry Alcoa that way for about four years, that's my record. Sometimes, not often, shares get merged into something else, the company files bankruptcy, etc., doesn't happen a lot.
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Here's a link to a Put and Call Finder by another Fool member

http://rmd4ylt1.pythonanywhere.com/
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Paul:

Yes, that's a bunch of questions you ask! ;)

In no particular order, 1- anchoring is a very bad habit we all tend to have. No one but you cares at what price you bought, it's not going to affect the stock's price going forward.

2- like I said in my post, selling covered calls is helpful when a stock drops because your cost basis is lower. Not selling the calls would not have stopped the stock price from falling so "... those nice premiums I was receiving seem quite meaningless given the magnitude of value reduction in the underlying" is meaningless.

3- take Will Rogers' advice "Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it.

https://www.brainyquote.com/quotes/will_rogers_161236

4- 1% a month on premiums alone is very aggressive (I was doing 4 to 5% annualized). 1% a month on premiums plus price appreciation is too low.

5- before Covered Call Selector selling calls was incidental to regular investing. With Covered Call Selector it tells me what stock to buy from my list. The list is basically high growth, asset light, credit risk free, high tech -- NPI and Saul stocks.


I know I embedded several questions there, and really, my main question is about mitigating against a big drop in value with the underlying position, especially when you are targeting high premium, highly volatile positions.

Cash secured puts really do screw you which is why I stopped doing it. Sell covered calls only! Diversify.

Did I cover it all?

Denny Schlesinger
 


PS: Bought OKTA at $109.25, sold 113 May 31 calls at $4.30, very close to what Covered Call Selector figured. Premium DPD $35.46, if called DPD $29.63 for total DPD $65.08

BTW, if the stock craters, that's a 3.9% protection.
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rule of thumb: 65% - two thirds, but depend on how close to expiration, time value drops very fast the last few days. Just to be safe I now enter GTC buy back orders at 65%

Bulls make money, bears make money, pigs get slaughtered! ;)

Denny Schlesinger
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Denny,

Yes, Thank you.

I have thought of cash secured written puts and covered calls as mostly equivalent. Your response has clarified some of the difference.

The point that a 1% target for put premiums is aggressive, yet you expect better than that with a more modest covered call (premium combined with appreciation of the underlying) is quite helpful and gets to the main question I was trying to ask.

It’s hard to pass up those nice put premiums sometimes even though I understand they are high for a reason. The ones I write nowadays are on positions that I would be ok with owning, so assignment is generally a decent outcome. But, as noted before, I’ve been burned pretty good when something unexpected comes along to mess up my thesis on the position. If only I would have taken Will Rogers’ advice!:)

Thanks again for taking the time to respond.

Best Regards,

Paul
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