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With bonds not paying much interest, and the possibility of big losses with rising interest rates, anyone here actively creating "bond substitutes" with deep ITM covered calls, maybe on dividend-payers?

If so, please share your experiences. And if not, love to hear your thoughts, pros and cons. Thanks.
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IlanBigfoot: With bonds not paying much interest, and the possibility of big losses with rising interest rates, anyone here actively creating "bond substitutes" with deep ITM covered calls, maybe on dividend-payers?

If so, please share your experiences. And if not, love to hear your thoughts, pros and cons. Thanks.


Never even heard of such a thing. But it's an interesting (intriguing even) question.

So can I turn your request back to you and ask your thoughts pro and con? Why did you even bring it up? You must have given it some thought, or read about this as a strategy.

I have never had any interest in bonds, for what it's worth. I'm well into my retirement years (turned 79 recently) and have mostly equities (in the form of stocks and ETFs) in my IRA. No bonds, but enough cash to cover up to four years of RMDs..... I do trade options, following the thinking here in the Fool Options service. I made a good return, over all, on the options portion of the IRA, following the generally conservative philosophy preached here.

Why would one even think of deep ITM covered calls as anything other than deep ITM covered calls?

mathetes
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I've been doing it a lot since bond yields are way down.

You can buy ETY and they will do it for you (Eaton Vance Diversified Equity Income Fund). I bot a bunch of shares of ETY in 2013. I'll see if I can crank out my annual yield sometime, it should be at least 9%, probably more. (P.S., you can't sell covered calls against ETY shares).

If you do it with dividend payers, remember to watch for the dividend cut-off date.

With no commissions nowadays, you can sell a covered call or warrant with a short expiration date coming up...a few weeks out, or maybe a month. Once that's executed, you can buy it back just before expiration (very little premium), and sell the next covered call/warrent. Takes a little more time, but pays off better than just selling an option/warrant that's 9 months to a year out.

I presently have positions in NLY, SO, and Wells Fargo with covered calls sold against those shares.

For me, Etrade has the best position to execute buy-write trades or buy-option/sell option trades.
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oops...in the last sentence, I meant "platform", not "position".
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This past summer, I bot shares of MGI in about a dozen different purchases. For each trade, I bot X number of shares and sold X number of call options against those shares...all in one transaction. Etrade worked well for that. The options were near term, with only a month or less till expiration,$2 or $3 strike prices. Three or four or five days before expiration, I'd buy those options back, and sell the next ones on the calendar. I've been doing that for awhile. Presently I've got $2, $3, and just a few $4 covered calls, expiring in jan, feb, and may, sold against all my MGI shares.

My returns are all looking to yield 9 to 10%..a little more if someone calls some of my shares away earlier. That works for me. With shares trading now at $5 to $6, I'm not expecting to start any new transactions once my existing ones close out...unless there will be enough premium on the $2 and $3 calls to make it worthwhile.

MGI does not pay a dividend. MGI got my attention from watching all the transactions done at Walmarts, small stores, etc....understanding the need for people to do a lot of under-the-radar cash transactions...MGI's announcment a year go about intending to start their own crypto currency...and the numbers in their quarterly earnings reports.
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I pulled up the chart on MGI, and this summer it was around $2-$3.

$2.94 on Oct 1 and $4.82 on Nov 1.

High of $8.77 on Nov 17 and now down to $5.69.

I don't see how price action like this makes for a good covered call stock. It shows both of the negative aspects of a covered call. When the price goes up big, you miss out on all the gain above the strike. When the price goes down big, you eat the entire loss except for the small premium you collected.

If you were investing with MGI this summer at $2 and $3, the best move would have been to just buy it outright. Because it's now at double and triple that. Up 100% - 200%, way more than 9%.

[edit] Oof!! Have you seen the 5 year and 10 year charts for MGI? Ugh!!
Or if you really want to cry, look at the chart from 2000 to 2020.
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Why would one even think of deep ITM covered calls as anything other than deep ITM covered calls

I tried these at one time. For every dividend paying stock I checked the call premium plus the dividend was a few percent superior to the equivalent put at the same strike. Even though in theory they should be about the same.

I was doing the covered calls as buy-write combos. The feature I liked was that the outlay of cash was reduced significantly by the the ITM call. In percentage terms the dividend yield was thereby enhanced. You are effectively earning a dividend yield on borrowed money.

A big drawback with a high yielding dividend stock is that once the dividend exceeds the time value in the call your shares will be called early.

And of course, you still have all the down side of the stock and you've sold the up side.
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The only reason one should be doing in-the-money covered calls is for INCOME!

If someone else bot MGI in the $2 - $3 range for appreciation in share price, I would say Well done! T

To the folks that sold me those shares in the $2 - $3 range...my sympathies, I hope you did well with the receipts from the sale.

When writing in-the-money covered calls against dividend paying stocks, you need to figure in the ex-dividend date. Otherwise, what your expecting yield might be greatly reduced if the shares are called early.

Consider risk/reward.
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I don't like the idea of starting a position as an ITM CC. You accept most of the downside risk with none of the upside potential. I don't see where DITM CC's generate enough net premium on short term options to make this a worthwhile strategy.


That said, I've been doing OTM CC's buy/write as a substitute for preferreds. My assignment return profile with OTM B/W CC's makes the risk acceptable to offset when a position goes the wrong direction. I also don't want to lose my dividends which can happen when your position is ITM. I'm always happy to sell time for upside in these positions when rolling a position that is ITM at expiration.

Zero commissions allow me to keep positions sizes small. I utilize weekly expirations when available so that positions are staggered. Still have most positions expiring on standard monthly date. When weekly options are available I typically have multiple positions in the same security with staggered expirations dates and/or strike prices.

I opened a 46 day OTM B/W CC position yesterday with 1.6% upside and 1.6% option premium, 1% dividend also. 39.2% annualized return if assigned at expiration, 20.6% annualized income if not assigned. 61.8% annualized return if assigned for the dividend in 24 days.

John
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I did a few deep ITM covered calls in april and may, when I believed there will be a W type recovery, and considered we were near the second leg down, or with stocks that I considered risky

as an example,
04/07/2020 13:04:30 Bought 700 RCL @ 35.9
04/07/2020 13:04:30 Sold 7 RCL Apr 17 2020 32.0 Call @ 7.03

04/16/2020 10:05:03 Bought 7 RCL Apr 17 2020 32.0 Call @ 3.18
04/16/2020 10:05:03 Sold 7 RCL Apr 24 2020 32.0 Call @ 4.83

04/23/2020 10:22:43 Bought 7 RCL Apr 24 2020 32.0 Call @ 3.6
04/23/2020 10:22:43 Sold 7 RCL May 1 2020 32.0 Call @ 4.7

04/30/2020 03:23:05 Sold 700 RCL @ 32 (assignment)

So I made $4116 (less 17.5 comissions) on $20209 risked capital, and protected to the downside with an initial breakeven point of 28.87

Did similar things with CCL, AAL, BA, USL, SRNE, HTZ, ZM and I earned a lot or it helped me minimize the losses (HTZ)

Could have won more if I just buy and hold? Yes
Am I happy with what I made? yes, because it made me money while protecting me from a possible new crash

Right now, the volatility is too low for that strategy to work, so with part of my portfolio I look for "stable" stocks and write ATM or slightly OTM
If it goes down, I´m happy that I lowered my cost in stocks that I like, and I may average down

GLTA!
Edgardo
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