Crazy NonBH Strategy of Playing Options on ETFs?

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msk
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Crazy NonBH Strategy of Playing Options on ETFs?

Post by msk » Thu Oct 27, 2016 10:35 am

OK, anyone not familiar with options, please do NOT get into this. Definite danger of getting too greedy and losing some serious money! but for those who are familiar with Call and Put options, please comment.
A couple of years ago I got this feeling (still have it) that the SP500 is getting over-valued to a non-sustainable extent. Since I had some serious $ in SPY I watched it bobbing up and down and basically drifting sideways. Whenever SPY approached $220 (SP500 approaching 2200) I would sell Covered Calls on my full position to a date roughly a year out at a Strike Price slightly above 220. Then wait. Sure enough, SPY drifted down and I pocketed the Premium I collected for the Calls. I did not have to wait a whole year. E.g. SPY would drift down below 215 and I would collect some 60 to 75% of the premium by buying back my Calls. This worked a few times already. I have since switched over IWDA (think of it as the nearest equivalent of VT, total world stocks ETF). The numbers work as follows, assuming you have serious money in VT:

VT is currently trading at $59.9, Calls at a Strike of 60 maturing in May 2017 (7 months out) trade at about $2.95; i.e. you collect 4.9% of the value of your holding as a Premium. If VT drops in price, you have already collected 4.9% (nice insurance!), if VT stays static, drifting sideways, you simply wait till May 2017 and again pocket the 4.9%. If VT rises by more than 4.9% your Calls get exercised and your gain is just 4.9% plus any dividends you have already collected. Now, let's extend things to a year, since this exercise is repeatable: the Premiums you collect increase by *12/7 to 8.4%. Add in a Dividend of 1.5% and you end up making almost 10% per annum with the only risk being to forego VT shooting up by more than 8.4% within a year.

Comments anyone? I have done it a few times successfully with my holdings of SPY over the past two years with SPY drifting sideways. Actually I also wanted to add to my holdings of SPY but held back, and each time SPY dropped significantly I would sell Puts. They never got exercised, so I never did add to my SPY but I kept collecting the Premiums. For some reason VT offers even larger Premiums than SPY. Looks like the only reason not to replay this game on VT is if we expect VT to rise by more than 8.4% p.a. Really? Your views. Fear and Greed...

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oldcomputerguy
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Re: Crazy NonBH Strategy of Playing Options on ETFs?

Post by oldcomputerguy » Thu Oct 27, 2016 10:42 am

My first thought was, why are you coming to the Bogleheads forum for advice on what you admit is a "crazy non-Boglehead strategy"? I would think that would be counter to your desired outcome.
"I’ve come around to this: If you’re dumb, surround yourself with smart people; and if you’re smart, surround yourself with smart people who disagree with you." (Aaron Sorkin)

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Re: Crazy NonBH Strategy of Playing Options on ETFs?

Post by Wagnerjb » Thu Oct 27, 2016 10:45 am

smartinwate wrote:My first thought was, why are you coming to the Bogleheads forum for advice on what you admit is a "crazy non-Boglehead strategy"? I would think that would be counter to your desired outcome.
I agree. Why don't you seek advice on a board known for active strategies?
Andy

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msk
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Re: Crazy NonBH Strategy of Playing Options on ETFs?

Post by msk » Thu Oct 27, 2016 10:56 am

I came across BH fairly recently and I am aware that at my age I needed to simplify my investments, in case of a stroke or sudden death. This I have done, in a very BH way. Nevertheless there are some very savvy investors on this board, perhaps the most savvy I have come across on any investment board. There are endless discussions on how to eke out that last 0.1% in returns by using some perfect mix of AA. So I was wondering whether anyone else was playing the Covered Calls game in this quirky, super low interest rate period in history... PS. I am not aware of any active strategies that actually work better long term than the BH approach. Covered Calls worked for me in recent times simply because of a certain, sideways drift in SPY. It's certainly not a strategy I would advocate under "normal" times. But then again, nobody sends us an email telling us that normal times have begun :)

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Don Christy
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Re: Crazy NonBH Strategy of Playing Options on ETFs?

Post by Don Christy » Thu Oct 27, 2016 11:56 am

Long term investors typically aren't interested in the effort, complexities, tax issues, etc... and as you note, you miss out on significant appreciation moves... also if the covered stock plummets, you're limited in getting out, scrambling to rebuy calls. Unable to rebalance... just goes against most of what BHs think is sound strategy.... and it Sounds like work with no long term value.
“Speak only if it improves upon the silence." Mahatma Gandhi

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JoMoney
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Re: Crazy NonBH Strategy of Playing Options on ETFs?

Post by JoMoney » Thu Oct 27, 2016 3:18 pm

There is an index, CBOE S&P 500 BuyWrite Index (BXM) that tracks performance of a similar strategy, except without the subjective "...I got this feeling (still have it) that the SP500 is getting over-valued to a non-sustainable extent"
and the options are usually rolled monthly instead of yearly, which could make a difference since there is less of a premium on the time decay.
But the performance really hasn't been anything unusual or exciting
Morningstar Chart
To me, this mostly seems like a way to generate commissions for brokers with all the trading involved.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: Crazy NonBH Strategy of Playing Options on ETFs?

Post by alex_686 » Thu Oct 27, 2016 4:14 pm

It is not crazy but I would not recommend it.

The strategy increases complexity, taxes, and transaction costs. All manageable items but it makes things a bit harder.

The academic literature that I have read suggests that the return in investing in the S&P w/ covered call writing is slightly, but not statistically, higher than a straight S&P verse is about the same.

During normal periods covered call writing offered more consistent returns. That is good. However, your underperformance during strong runs don't make up for the bear markets. In short, it is a mixed bag. You can achieve basically the same result by increasing your AA to bonds.

Lastly, some transaction questions. I am guessing that the spreads are better on the S&P verse the IWDA. The spreads on long dated options tend to be higher. Due to the volatility smile, premiums tend to be lower. Have you considered these factors?

inbox788
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Re: Crazy NonBH Strategy of Playing Options on ETFs?

Post by inbox788 » Thu Oct 27, 2016 4:52 pm

Like any covered call strategy, the big pitfall is that you're capped on the upside, but not on the downside. The downside events are rare, but when the occur, and they will occur, it usually wipes out all the benefits. Would this have been wise in 2006 or 2007? How long before you would have broken even then? or at all if you simply got discouraged and exited the game at a loss? And compare the strategy to simply owning SP500.

Also, keep your eye on the VIX. It's been mostly under 20, so you're not getting that much premium. And when it's over 25, the risk is higher, so think about your willingness to stay in the strategy during those periods.

Finally, the trading costs and taxes (short term capital gains) mean that even if you win, you could still lose.

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Re: Crazy NonBH Strategy of Playing Options on ETFs?

Post by AlohaJoe » Thu Oct 27, 2016 5:02 pm

What is "serious money"? I'd consider $20 million serious money. Is that how much it takes to execute this strategy?

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Don Christy
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Re: Crazy NonBH Strategy of Playing Options on ETFs?

Post by Don Christy » Thu Oct 27, 2016 7:59 pm

inbox788 wrote:Like any covered call strategy, the big pitfall is that you're capped on the upside, but not on the downside. The downside events are rare, but when the occur, and they will occur, it usually wipes out all the benefits. Would this have been wise in 2006 or 2007? How long before you would have broken even then? or at all if you simply got discouraged and exited the game at a loss? And compare the strategy to simply owning SP500.

Also, keep your eye on the VIX. It's been mostly under 20, so you're not getting that much premium. And when it's over 25, the risk is higher, so think about your willingness to stay in the strategy during those periods.

Finally, the trading costs and taxes (short term capital gains) mean that even if you win, you could still lose.
How are you not capped on the downside? Just have to sell (and be uncovered and unlikely called) or sell and repurchase calls to close out uncovered calls.

PS: as I say up thread, I think that it's too much work for too little potential benefit and some risks.
“Speak only if it improves upon the silence." Mahatma Gandhi

afan
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Re: Crazy NonBH Strategy of Playing Options on ETFs?

Post by afan » Thu Oct 27, 2016 8:34 pm

If you watch the market constantly you need not give up appreciation as the market goes up. You know the strike price. As soon as you are forced to sell to meet your call you buy again at the then market price. If you do this the moment you face the call then there is little room for stocks to go up between your forced sale and your purchase.

But lots of turnover, short term capital gains if you do it in a taxable account and transaction costs. At least it is not selling puts.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

ved
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Re: Crazy NonBH Strategy of Playing Options on ETFs?

Post by ved » Thu Oct 27, 2016 9:24 pm

afan wrote:If you watch the market constantly you need not give up appreciation as the market goes up. You know the strike price. As soon as you are forced to sell to meet your call you buy again at the then market price. If you do this the moment you face the call then there is little room for stocks to go up between your forced sale and your purchase.

But lots of turnover, short term capital gains if you do it in a taxable account and transaction costs. At least it is not selling puts.
Let's say you wrote a call with StrikePice of $60 for a call maturing in May2017.
What if the stock goes to $61 in March? The option will not be called until May. Do you hope that the stock goes below $60 by May and sit tight? Or, do you immediately buy another set of shares thinking (fearing) that the option will be called in May?

Or, take this scenario: The share price in May is $75, and the option is called (that is you sell at $60). Do you then buy more shares at $75?

That's why writing a call has a limited upside.

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Re: Crazy NonBH Strategy of Playing Options on ETFs?

Post by SpaceCowboy » Fri Oct 28, 2016 12:35 am

Would you write a naked Put on the index?
If yes, then a covered call is a suitable strategy. If no, then you shouldn't and are probably fooling yourself.
Basic options theory: Call = Stock + Put ---> -Put = Stock - Call
If you don't understand this, you shouldn't be trading options. The only reason to buy or sell an option is because you believe the underlying will have a different volatility than its price implies.

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Re: Crazy NonBH Strategy of Playing Options on ETFs?

Post by NOVACPA » Fri Oct 28, 2016 5:09 am

I write weekly naked puts or covered calls in my brokerage account. The decay in the options is rapid.

I do it with a fixed amount of capital of $11,000. This is the amount I have set aside for my IRA contributions.

Due to the favorable tax treatment of index options (60/40 LT/ST Capital Gains) it beats having the funds locked up in the IRA longer than it needs to be. I value the liquidity premium highly.

Basically, I profit off the ebbs and flows (aka volatility) of the market before the funds go into the IRA.

It should be noted I use options, futures, and swaps for work professionally, so I have a handle on what I'm doing.

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msk
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Re: Crazy NonBH Strategy of Playing Options on ETFs?

Post by msk » Fri Oct 28, 2016 10:51 am

Good to see that there are others who play this game despite being BH at heart. I fell into it simply because I became frustrated with the sideways drift in SPY seeming never ending, yet constantly wary of a possible massive decline, so looked for a strategy that was relatively safe (only foregoing the upside in case SPY breaks upward). I thought making a sure 6% p.a. was better than collecting just the dividend (that had tax withheld) on SPY. My tax status is simple (no capital gains tax, I just have tax withheld on dividends). Main reason I chose a term of around one year was because on my $ position in SPY one got a nice non trivial sum when writing covered Calls. Similar percentages of course when writing naked Puts for planned additions to SPY position. But I think weekly trades in options is probably too intense a job for a retiree like myself. :beer

ValueInvestor99
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Re: Crazy NonBH Strategy of Playing Options on ETFs?

Post by ValueInvestor99 » Fri Oct 28, 2016 12:53 pm

The implied volatility on ETF funds is low, making the profit low.
Stocks with high dividends have a similar problem.
The shorter the time to maturity, the higher the implied volatility, unfortunately
not all stocks have weekly options.

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