Downside of selling covered calls

[Hector]

Suppose I hold a stock position currently at a loss and intend to sell it to realize a capital loss. Beyond the risk of additional losses if the stock price declines further, what are the downsides of selling a covered call, particularly if I have no intention of repurchasing the stock?

[heisenberg.]

You’re selling the upside? Ie depending what strike price you write the calls at you have given up on any potential recovery

[WarpSpeed]

The two downsides I see:

1. You will need to hold the stock until the calls expire if you want to capture all of the premium (assuming the price remains below the strike price). If the stock declines or holds steady, you won't be able to sell before call expiration without buying back the calls (although they would probably be very cheap).
2. If the stock starts rising and rises above the call price, your upside is limited and you will be called when the options expire. But if you're already planning to sell at a loss, perhaps not a big deal for you.

Options are essentially "guesses" about the stock price on a particular future date. If you're already planning to sell at a loss and you don't mind further losses as you hold the stock (which is certainly possible), then you can capture option premium by writing the upside calls. But the amount of premium is going to be small compared to the potential downside of continuing to hold a losing stock.

If you don't believe the stock will recover and you're planning to sell because you see more downside than upside, it's probably safer to just sell now vs. writing upside calls and holding (hoping you don't see further declines).

[alex_686]

Why would you want to do this?

I suspect that this isn't some rational plan but rather a desperate (i.e. irrational) attempt to claw back a losing position.

[Hector]

You’re selling the upside? Ie depending what strike price you write the calls at you have given up on any potential recovery

Yes. I am either selling stock or selling covered call because my goal is to realize capital loss.

[Hector]

Why would you want to do this?

I suspect that this isn't some rational plan but rather a desperate (i.e. irrational) attempt to claw back a losing position.

Since I intend to sell the stock to realize a capital loss, as mentioned in my original post, I am considering one of the following two approaches:
1. Sell the stock immediately to capture the capital loss.
2. Sell a covered call now and wait. If the stock price rises and the call is exercised, I will let the shares be called away. If the call is not exercised, I plan to sell another covered call and continue the process until it is.

FWIW, I don't have a loosing position that I am selling. This is for educational purpose.

[psteinx]

Suppose I hold a stock position currently at a loss and intend to sell it to realize a capital loss. ***Beyond the risk of additional losses if the stock price declines further***, what are the downsides of selling a covered call, particularly if I have no intention of repurchasing the stock?

Other than THAT, how was the play, Mrs. Lincoln?

Yes, you remain exposed to the downside, while losing the upside (with the particulars depending on the strike price, date, etc.)

It's not a free lunch.

If you want to sell the position, sell the position, don't monkey around with covered calls.

[alex_686]

Why would you want to do this?

I suspect that this isn't some rational plan but rather a desperate (i.e. irrational) attempt to claw back a losing position.

Since I intend to sell the stock to realize a capital loss, as mentioned in my original post, I am considering one of the following two approaches:
1. Sell the stock immediately to capture the capital loss.
2. Sell a covered call now and wait. If the stock price rises and the call is exercised, I will let the shares be called away. If the call is not exercised, I plan to sell another covered call and continue the process until it is.

FWIW, I don't have a loosing position that I am selling. This is for educational purpose.

Which takes me back to my original question - why?

You have a very plan. Your plan says to sell. You don’t. Instead you write covered calls. Why the delay? Why not sell outright?

For context, I used to work the option section of the margin desk back during the dot.com boom and bust. I didn’t see much in the way of rational planning.

I now work on a different option desk with lots of planning. You explained the how but not the why. The normal answer is to manage risk. Maybe there is some tax considerations.

[bh1]

In an effort to not be hostile....back when I was first interested in options, I did exactly the same thing for the same educational reason; I sold covered calls on a stock I didn't want until it was called. Options are always a fair deal, so you are trading some guaranteed money in exchange for loss of potential upside gain. Maybe such a move makes sense if, say, the potential future gain puts you into a higher tax bracket? You have also reduced the volatility of your portfolio, assumedly accompanied by some corresponding loss of something. I keep options available in my brokerage account for the unlikely event that I ever want to do this again.

[unbiased]

This is a classic "stock repair" tactic that may/may not minimize losses--if that it is a goal. You've explained the pluses/minuses, and it's not necessarily unreasonable. Of course, the stock could keep dropping and then you've got an even bigger capital loss that may/may not be mitigated by the call premium. My biggest fear here would be falling into the sunk cost fallacy.

[comeinvest]

There was a thread about options selling strategies a while ago.
Over time I learned that the best way of thinking of an options position or options writing strategies is not the final payoff diagram, but rather to think of it as a dynamically hedged position (if you wanted to) that provides a certain constant beta exposure (called delta in options speak), along with an opinion on future volatility. The volatility assumption can be theoretically derived using stochastic calculus by considering the option position, dynamically hedged with the underlying stock (continuously replicating portfolio).

[psteinx]

The major downside of most options strategies, including covered calls, is that retail investors cross relatively big bid/ask spreads with every transaction, and most option strategies have a LOT of transactions (monthly or perhaps more often). IIRC, commissions (to your broker, not your counterparty/market maker) can also be high.

So, you're re-shaping your risk/return profile somewhat (not inherently good or bad), but in a relatively inefficient way. (The high costs).

And, for OP, it sounds like this is mainly a way to try to avoid facing up to his/her losses - soften the blow. It *might* soften the blow, but it also might make the blow worse (if the stock continues to fall).

[Hector]

Since I intend to sell the stock to realize a capital loss, as mentioned in my original post, I am considering one of the following two approaches:
1. Sell the stock immediately to capture the capital loss.
2. Sell a covered call now and wait. If the stock price rises and the call is exercised, I will let the shares be called away. If the call is not exercised, I plan to sell another covered call and continue the process until it is.

FWIW, I don't have a loosing position that I am selling. This is for educational purpose.

Which takes me back to my original question - why?

You have a very plan. Your plan says to sell. You don’t. Instead you write covered calls. Why the delay? Why not sell outright?

For context, I used to work the option section of the margin desk back during the dot.com boom and bust. I didn’t see much in the way of rational planning.

I now work on a different option desk with lots of planning. You explained the how but not the why. The normal answer is to manage risk. Maybe there is some tax considerations.

I don't have a definitive answer. Given the sufficient carryover capital losses I currently have, selling losing positions isn't particularly urgent right now.

[Hector]

The major downside of most options strategies, including covered calls, is that retail investors cross relatively big bid/ask spreads with every transaction, and most option strategies have a LOT of transactions (monthly or perhaps more often). IIRC, commissions (to your broker, not your counterparty/market maker) can also be high.

So, you're re-shaping your risk/return profile somewhat (not inherently good or bad), but in a relatively inefficient way. (The high costs).

And, for OP, it sounds like this is mainly a way to try to avoid facing up to his/her losses - soften the blow. It *might* soften the blow, but it also might make the blow worse (if the stock continues to fall).

My approach to selling stocks has always been straightforward: I prioritize those with the largest losses or, if there are no losses, those with the smallest gains (percentage-wise), all while accounting for wash sale rules and long/short-term gain considerations. My strategy is simple—I can’t predict how any stock will perform tomorrow, but I do know the implications for my taxes.

[Tramper Al]

I don't have a definitive answer. Given the sufficient carryover capital losses I currently have, selling losing positions isn't particularly urgent right now.

You have to book losses when you can. If it means years of $3000 ordinary income deductions, that's a great outcome.

My only question here would be: what am I going to buy to replace this sale, within mere minutes if at all possible, so that my asset allocation (exposure) remains intact and I am not running a one off program of buy high, sell lower.

I understand options, but I don't understand this.

[Hector]

I don't have a definitive answer. Given the sufficient carryover capital losses I currently have, selling losing positions isn't particularly urgent right now.

You have to book losses when you can. If it means years of $3000 ordinary income deductions, that's a great outcome.

My only question here would be: what am I going to buy to replace this sale, within mere minutes if at all possible, so that my asset allocation (exposure) remains intact and I am not running a one off program of buy high, sell lower.

I understand options, but I don't understand this.

Whatever your AA calls for.

[bd7]

Suppose I hold a stock position currently at a loss and intend to sell it to realize a capital loss. Beyond the risk of additional losses if the stock price declines further, what are the downsides of selling a covered call, particularly if I have no intention of repurchasing the stock?

If the call is exercised you'll realize less of a loss (not really a problem) and if it is not exercised you'll realize a short term gain without realizing the loss that you were after in the first place--unless you sell the stock separately. There's nothing wrong with doing this if your stock is fundamentally solid with not too much chance of significant further decline. However, making that determination that your stock isn't going to keep fading is the issue and I've been wrong a few times on this.

[bsteiner]

Options are a zero sum game minus the transaction costs, which can be substantial.

[BuglheadLuvsLondon]

Beyond the risk of additional losses if the stock price declines further...

Why do you need any downsides beyond that?

It's gambling, pure and simple.

Alternative: Reserve a nice suite at the casino, go away for a weekend, play the slots, and have a good time. It's money better spent than selling covered calls.

Cheers.

[tdgb]

Not much to add to previous responses, however, I do encourage you (and anyone interested in option trading) to read at least the abstract of this paper: https://www.sciencedirect.com/science/a ... 6608002720
"The results show that most [retail] investors incur substantial losses on their option investments, which are much larger than the losses from equity trading." I don't know your particulars but, statistically, whatever you do, you are very likely to lose.

[deltaneutral83]

Options is simply putting up less to get more exposure with the market timing element, almost like leverage, but not quite IMO. It is not a free lunch, as many who are new to it will proclaim (particularly around covered calls). Options on the indexes aren't as juicy since the index is no where near as volatile as singe stocks. Only reasonable avenue for most is to collar a stock that's in lockup when you have a sizable allocation (Mark Cuban when he sold his Broadcast.com to Yahoo and got Yahoo shares that were locked up for a period) and want to lock it in.

There are very complex option strategies out there but selling covered calls, synthetic longs (selling OOM put to purchase OOM call to get synthetic ownership with price movements), and basic OOM put selling ("because I don't mind owning it at that price") that I see the financial media covering the most. It's almost guaranteed you're stock is going to plummet for all eternity or race past your strike and even if you had 6 months of successfully doing this eventually it's going to blow through your strike for good (either direction) and you will have had all your profits evaporate. I don't know of anyone on the retail side who successfully sold covered calls who has made any money, say over the course of ten years. If anything there are up a tad but have devoted hours upon hours to it on their index funds (with tax consequences in their taxable). Many more get their face ripped off.

[Thesaints]

If the OP’s objective is to realize capital losses, why would he wanted to realize short term capital gains by writing options ?

[Hector]

If the OP’s objective is to realize capital losses, why would he wanted to realize short term capital gains by writing options ?

Because OP has enough carryover losses to not pay capital gain tax.
If security is not called, OP is happy with premium
If security is called, OP is happy with premium + capital losses

[Morik]

Note that you are also giving up potential upside on whatever other thing you would have put the money in if you sold now.
What would you do with the money if you sold now? If the answer is invest it in some other etf/stock/etc, then by holding onto the old stock you are risking missing out on growth in whatever you would have bought with the sale proceeds.

[Hector]

Note that you are also giving up potential upside on whatever other thing you would have put the money in if you sold now.
What would you do with the money if you sold now? If the answer is invest it in some other etf/stock/etc, then by holding onto the old stock you are risking missing out on growth in whatever you would have bought with the sale proceeds.

Makes sense.

[firebirdparts]

Suppose I hold a stock position currently at a loss and intend to sell it to realize a capital loss. Beyond the risk of additional losses if the stock price declines further, what are the downsides of selling a covered call, particularly if I have no intention of repurchasing the stock?

The obvious downside is that you'll miss whatever the difference is between the call and the price.

I have experienced some worse versions of that, but honestly, nobody would believe them.

[Kbg]

The only downside is possibly recovering less of your loss if the stock recovers. In every other scenario selling an option will be more profitable as it will have provided some cushion to whatever the additional loss would be or add to the amount received if the stock goes no where..

If for some reason you are afraid of further loss, you could sell an in the money call that would cushion the fall in exchange for less premium value received.

Assuming you are definitely going to sell and aren't hoping for a recovery, the most profitable thing to do is sell a very short term near the money call. This will maximize the time value of money to be received (e.g. highest imputed interest rate).

Of course the stock could go down and the best thing to have done would have been to just sell. Statistically a delta of .5ish which is in the ballpark of an ATM call is a 50/50 chance of up or down from the point sold over the duration of the option.

Bottom line: There is no known concerning future price. The tradeoffs are known in advance, the final result is not.

If it were me I would either A) unload the thing and be done with it, B) attempt to sell multiple short term calls slightly out of the money until called away. You could get lucky with B (or not).

[evancox10]

Suppose I hold a stock position currently at a loss and intend to sell it to realize a capital loss. Beyond the risk of additional losses if the stock price declines further, what are the downsides of selling a covered call, particularly if I have no intention of repurchasing the stock?

Bolded part is very much “Other than that, how was the play Mrs. Lincoln?”

Normally when you hold a stock, you are compensated for the downside risk with the possibility of large gains. Once you’ve capped your upside, it’s kind of a lousy investment. All downside risk and minimal upside. So the main drawback of your strategy is exactly what you tried to waive away, namely the stock might keep going down, but you won’t reap the gains if it goes up.