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A New Covered Call Paradigm

Call options are a bet that the stock price will rise above the strike price by more than the premium by the expiration date. Premiums are higher with high volatility because the bullish outcome is more likely with high volatility but so is the opposite.

What Is a Call Option?

There are many reasons to trade call options, but the general motivation is an expectation that the price of the security you're looking to buy will go up in a certain period of time. If the price of that security does go up (above the amount you bought the call option for), you'll be able to make a profit by exercising your call option and buying the stock (or whatever security you're betting on) at a lower price than the market value.

In essence, a call option (just like a put option) is a bet you're making with the seller of the option that the stock will do the opposite of what they think it will do.

Make no mistake, this is not investing, it's trading. Call buyers need a place to make their bets. Covered call sellers meet at the Chicago Board of Option Exchange just like Lloyd's coffee house in London was the place for insurance underwriters. Unlike casinos and in line with Lloyd's, the call seller picks which trades he wishes to cover and the price at which he is willing to cover.

Traditionally an investor has a portfolio, however picked, and offers to sell calls to create an income stream. But what if we turn this paradigm upside down? The investor is fully in cash. Each week he searches out the calls with the highest outcomes, buys those stocks, sells weekly calls, and closes the trades on the weekend? By using this method, instead of getting average premiums sellers get the highest available. Because the seller is not interested in keeping the stocks, he sells at the money calls hoping that all the calls will be assigned and he is back 100% in cash by Monday.

What kind of results can one expect? Since there are 52 weeks in a year, there are only 52 trading sessions, round it to 50 for easier computation. At 2% in weekly premiums, provided no stock crashes badly, you are more than doubling your money each year. The risk is getting stuck with underwater stocks. If you are aiming at a market beating 20% instead of a doubling then 0.4% will do. The results depend on several variables like volatility, buyers' bullishness, and the stocks you are willing to trade.

Added Benefits

Serene weekends: because you are mostly in cash over the weekend you don't have to worry about weekend news. You do have to do some work on Sunday to pick your calls.

Free time: Unlike day traders who have to be at it every market day, this way of trading is reduced to three days a week: Sunday, find your calls. Monday, place your trades. Friday, record the week's outcome. Good for retirees!

New Selection Algorithm

Last week I made a series of changes to the Selector algorithm to get better and more realistic results. As I mentioned in my previous post, Discrete vs. Continuous Data, discrete data complicate comparisons. Previously I was using dollars per day as my primary search variable and then I tried to normalize the various picks by stock price. This method omitted some great picks. The new algorithm uses the discount to the stocks' price as a percentage by dividing the premium by the stock's price. This results in "continuous" style data (measured instead of counted) and the results are much improved as well as reducing the time required to process the option chains.

Below is the link to the screen shot of this week's finalists. I must hasten to add that the CBOE Volatility Index (^VIX) was around 33 while the more usual value is between 10 and 15. You won't see three and four percent discounts often but I don't know what to expect at between 10 and 15. My estimate is that there should always be some stocks the market is bullish on with corresponding high premiums. The peak on the left is 2008 and on the right Mar 2020.

VIX 2007 - 2020:

"disk" is the discount explained above and "yield" is the yield should the call be assigned, the wished for result. Of the five, MTCH was eliminated because it had lowest yield because it was the most in-the-money. The numbers shown don't quite add up because they take into account trade commissions not shown. These numbers are not the actual prices of the trades as the market moves quickly but the final average discount was 3.8%. All four stocks went up into the money which is what you want to happen.

Calls 6/22/2020:

Portfolio Management

This begs the question "how to distribute the portfolio?" Right now, excluding reserve cash, mine is two thirds growth stocks and one third covered call trading. Maybe just let each side do its thing.

Denny Schlesinger
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