Global Correction

[Firefan]

While I do not fit the description perfectly the way to live of ones investments, if holding equity, bonds, commodities, reits, Etc. is basically to first take the dividends/interest, and if that is not enough take from the main "winner" thereby re-balancing the portfolio back to the original risk profile (for example; back to 50% equity only after a an equity run-up which changed your equity exposure to 60% of portfolio.)

Now; one can naturally also have a market where everything drops - and one would then (after divvies and interest) take from the "loser" that lost the least.

Personally I would not have the guts to hold a 100% equity portfolio, a day like this Friday would simply hurt too much!

Cheers!

a question for the stock market/share lovers. how do you make a living with your investment (assuming you live of it and don't earn your money by working)? are you continously selling what went up to cover your living expenses? or are you well off enough to pay for your expenses with just the dividends?

[bingobongo]

US futures are looking quite ugly as of 8;00pm EST time, it should be a very interesting week for global markets......as the credit market continues to seize up

US Futures & Markets Indicators

S&P 500 -8.40 1498.60 10/21

NASDAQ -13.00 2136.50 10/21

Dow Jones -85.00 13485.00 10/21

Edited October 22, 2007 by bingobongo

[lannarebirth]

Stephen Roaches latest:

http://www.investorsinsight.com/otb_va_pri...x?EditionID=604

[lannarebirth]

a question for the stock market/share lovers. how do you make a living with your investment (assuming you live of it and don't earn your money by working)? are you continously selling what went up to cover your living expenses? or are you well off enough to pay for your expenses with just the dividends?

I'm not a stock market/share lover, but I can tell you the strategy a friend of mine employs. He's got a core position of about 15,000 GE shares. Every month he writes covered calls against his position. Each month he takes in a cash premiun of 1% to 5%. This is in addition to whatever paltry dividend it pays and appreciation (if any). He's been doing it for years. He uses the proceeds, both for income and to increase the size of his position.

http://stockcharts.com/h-sc/ui?s=GE&p=...id=p18708100323

[fletchsmile]

I'm not a stock market/share lover, but I can tell you the strategy a friend of mine employs. He's got a core position of about 15,000 GE shares. Every month he writes covered calls against his position. Each month he takes in a cash premiun of 1% to 5%. This is in addition to whatever paltry dividend it pays and appreciation (if any). He's been doing it for years. He uses the proceeds, both for income and to increase the size of his position.

http://stockcharts.com/h-sc/ui?s=GE&p=...id=p18708100323

Would be interesting to compare his returns vs a simple long position. Presumably sometimes the calls are exercised against him, and he then has to repurchase, which will attract transaction costs as well as subject him to price fluctuations between settlement dates.

[lannarebirth]

I'm not a stock market/share lover, but I can tell you the strategy a friend of mine employs. He's got a core position of about 15,000 GE shares. Every month he writes covered calls against his position. Each month he takes in a cash premiun of 1% to 5%. This is in addition to whatever paltry dividend it pays and appreciation (if any). He's been doing it for years. He uses the proceeds, both for income and to increase the size of his position.

http://stockcharts.com/h-sc/ui?s=GE&p=...id=p18708100323

Would be interesting to compare his returns vs a simple long position. Presumably sometimes the calls are exercised against him, and he then has to repurchase, which will attract transaction costs as well as subject him to price fluctuations between settlement dates.

He makes about 25% - 30% annually on the covered call transactions. Commissions are $USD 3.50/1,000 shares , so negligible. There's no real slippage due to settlement dates. Everything's instantaneous now. I can't imagine why anyone who holds shares in any stock wouldn't be collecting rent each month, as he does.

[fletchsmile]

I'm not a stock market/share lover, but I can tell you the strategy a friend of mine employs. He's got a core position of about 15,000 GE shares. Every month he writes covered calls against his position. Each month he takes in a cash premiun of 1% to 5%. This is in addition to whatever paltry dividend it pays and appreciation (if any). He's been doing it for years. He uses the proceeds, both for income and to increase the size of his position.

http://stockcharts.com/h-sc/ui?s=GE&p=...id=p18708100323

Would be interesting to compare his returns vs a simple long position. Presumably sometimes the calls are exercised against him, and he then has to repurchase, which will attract transaction costs as well as subject him to price fluctuations between settlement dates.

He makes about 25% - 30% annually on the covered call transactions. Commissions are $USD 3.50/1,000 shares , so negligible. There's no real slippage due to settlement dates. Everything's instantaneous now. I can't imagine why anyone who holds shares in any stock wouldn't be collecting rent each month, as he does.

The bit I was interested in is what is the real cost of this an ongoing basis. eg he writes call options at say 100 strike price on 15,000 shares he holds, and receives say 1% premium. From time to time the options will be exercised against him. Let's say market price is now 105. If deliverable, he must sell his shares at one hundred while MV is 100. i.e loss of 5 vs only 1% premium As you mentioned he tops up/replaces. This would cost 105 to replace in the market. If non-deliverable then he settles the diff but still loses the 5.

This I would suspect is the bit why people do not do this. If the options crystalise they lose. Writing options doesn't simply generate income via cash premiums, it also brings risk with it. OK it is limited as the options are covered by shares, but there is still risk. That's why everyone doesn't simply "collect rent". The options themselves will have spreads attached to them, eg if you wrote a call, and bought a put for exactly the same amounts, in many cases the premium received will be less than premium paid "tho' obviously depends on many other factors".

[fletchsmile]

BTW If he continually wants to hold the same core position, might be worth looking into stock lending. That's much more akin to collecting rent.

Edited October 26, 2007 by fletchthai68

[sonicdragon]

I'm not a stock market/share lover, but I can tell you the strategy a friend of mine employs. He's got a core position of about 15,000 GE shares. Every month he writes covered calls against his position. Each month he takes in a cash premiun of 1% to 5%. This is in addition to whatever paltry dividend it pays and appreciation (if any). He's been doing it for years. He uses the proceeds, both for income and to increase the size of his position.

<a href="http://"http://stockcharts.com/h-sc/ui?s=GE&p=...id=p18708100323"" target="_blank"><a href="http://"http://stockcharts.com/h-sc/ui?s=GE&p=...id=p18708100323"" target="_blank"><a href="http://"http://stockcharts.com/h-sc/ui?s=GE&p=...id=p18708100323"" target="_blank"><a href="http://stockcharts.com/h-sc/ui?s=GE&p=...id=p18708100323" target="_blank">http://stockcharts.com/h-sc/ui?s=GE&p=...id=p18708100323</a></a></a></a>

Would be interesting to compare his returns vs a simple long position. Presumably sometimes the calls are exercised against him, and he then has to repurchase, which will attract transaction costs as well as subject him to price fluctuations between settlement dates.

He makes about 25% - 30% annually on the covered call transactions. Commissions are $USD 3.50/1,000 shares , so negligible. There's no real slippage due to settlement dates. Everything's instantaneous now. I can't imagine why anyone who holds shares in any stock wouldn't be collecting rent each month, as he does.

The bit I was interested in is what is the real cost of this an ongoing basis. eg he writes call options at say 100 strike price on 15,000 shares he holds, and receives say 1% premium. From time to time the options will be exercised against him. Let's say market price is now 105. If deliverable, he must sell his shares at one hundred while MV is 100. i.e loss of 5 vs only 1% premium As you mentioned he tops up/replaces. This would cost 105 to replace in the market. If non-deliverable then he settles the diff but still loses the 5.

This I would suspect is the bit why people do not do this. If the options crystalise they lose. Writing options doesn't simply generate income via cash premiums, it also brings risk with it. OK it is limited as the options are covered by shares, but there is still risk. That's why everyone doesn't simply "collect rent". The options themselves will have spreads attached to them, eg if you wrote a call, and bought a put for exactly the same amounts, in many cases the premium received will be less than premium paid "tho' obviously depends on many other factors".

That is incorrect. The risk in writing covered calls is that the price goes down by more than the option premium collected.

If the market price is 105 and the strike is 100, then the option price (premium collected)cannot be 1% - it must be more than 5, and possibly a lot more than 5 depending on the time to expiration.

Most people who write covered calls do so with out-of-the money options - if the option expires in the money then they have effectively sold stock at the strike price plus the premioum received, whereas if it expires out of the money they simple keep the premium.

An exampe:

current price $100

Sell a 3 month $105 call at a price of $4

3 months later...

if the price is 110, then the option gets exercised at 105 and the writer has effectively sold at 109

if the price is 90, the option expires worthless and the writer keeps the $4 premium. If the same trade were repeated 4 times in a year at the same price, the writer would receive $16 in total premium (around 17% return on an annualised basis). Obviously he/she also has an unrealised loss of $10.

On a relatively stable stock like GE I would be quite surprised if 25%-30% were actually attainable.

Edited October 26, 2007 by sonicdragon

[sonicdragon]

BTW If he continually wants to hold the same core position, might be worth looking into stock lending. That's much more akin to collecting rent.

With stock lending, in a liquid widely held stock, the rate received is unlikely to be much more than short-term interbank deposit rates.

[fletchsmile]

That is incorrect. The risk in writing covered calls is that the price goes down by more than the option premium collected.

You sure about that? Your example below demonstrates the opposite and I believe your example below is correct. If he writes a call. That gives someone the option to exercise a buy against him. They will do so if the strike price is lower than market price. Hence if price rises his counterparty will exercise as the srtike price is cheaper than market. He covers this with his stock holding.

i.e risk is price goes up more than premium collected.

If the market price is 105 and the strike is 100, then the option price (premium collected)cannot be 1% - it must be more than 5, and possibly a lot more than 5 depending on the time to expiration.

No I wasn't saying market price at start was 105 that would be writing an in the money option, which would be unusual. Actually was simplifying and saying that at writing time price strike price was 100 and that "now" being if it now moved to 105 (afterwards). I omitted current market price at start of contract for simplicity, was trying to kepep simple. Bad wording on my part. Was trying to avoid a long numbers example and just reflect the risks/costs

Most people who write covered calls do so with out-of-the money options - if the option expires in the money then they have effectively sold stock at the strike price plus the premioum received, whereas if it expires out of the money they simple keep the premium.

Yes that's the risk I wanted to highlight. The c'pty will exercise if strike place (say 100) is lower than market price (moves to 105 "now"), i.e if "in the money" it will be exercised. The writer has the opposite position so loses out.

An exampe:

current price $100

Sell a 3 month $105 call at a price of $4

3 months later...

if the price is 110, then the option gets exercised at 105 and the writer has effectively sold at 109

if the price is 90, the option expires worthless and the writer keeps the $4 premium. If the same trade were repeated 4 times in a year at the same price, the writer would receive $16 in total premium (around 17% return on an annualised basis). Obviously he/she also has an unrealised loss of $10.

On a relatively stable stock like GE I would be quite surprised if 25%-30% were actually attainable.

Agree you've used 105 as strike and 110 as market price when exercised. I was using 100 at strike and 105 when exercised. The point being if market prices rises he can lose out. Using your example he sells a stock at 109 and replacement cost is now 110 i.e more. using mine he sells effectively at 101 and replacement cost is 105. Think we're saying the same point but badly worded in my first post

So it's not a simple rent and collect. As you say 25% looks very high...

Edited October 26, 2007 by fletchthai68

[sonicdragon]

Fletch, I won't bother to requote the the whole of the last post as it is very long and detracts from readability.

In your example you said "i.e loss of 5 vs only 1% premium". Where does the loss of 5 comes from ? What is the market price at the start of your example when the option is sold and the writer received his/her 1% premium ?

I'll re-iterate what I said above: the risk in a covered call position is a fall in price, not a rise. A rise in price is not a risk because there will always be a time value in the option price in addition to intrinsic value, and so writing a covered call simply puts a cap on the potential upside. The option writer has given up some of the potential upside in return for some current income. However the downside risk still remains.

If there was risk on the upside, then covered call writers would be required to post margin; however they are not required to do so.

[PCA]

why should he get exercised, this is the very exception to happen. If prices move up too fast he simply writes a higher strike. Beyond that after playing GE for a few years he knows the anatomy of the stock and most likely will not blindly doing always the same. Its an excellent and save way to generate income but you need to tie up quite a large amount of money.

[sonicdragon]

why should he get exercised, this is the very exception to happen. If prices move up too fast he simply writes a higher strike. Beyond that after playing GE for a few years he knows the anatomy of the stock and most likely will not blindly doing always the same. Its an excellent and save way to generate income but you need to tie up quite a large amount of money.

Well, if the option expires in the money then it *will* be exercised.

Prior to the expiry , if he wants to roll it to a higher strike then he has to buy back the first one - and then you are getting into the realms of rebalancing your gamma. Another example:

Price today = $100

Write a 3 month $105 call, receive $4

Price tomorrow: 110

Write a 3 month $115 call, receive $4

AND buy back the $105 call which is now in the money with a price around $11

Price on expiry date = $100 again

Net Net: Receive $8 in option premium, pay $11 for the 105 call

No gain or loss on the share. Result: not so good; it would have been better to have kept the short 105 call.

This is the problem of being short volatility (short gamma). When you have a short option position and the underlying share exhibits a lot of volatility you can have substantial losses. Short option sellers want low volatility. On the other hand people who own options (long volatility/gamma) are hoping for an increase in volatility.

[lannarebirth]

Sorry I was away and unable to respond. sonicdragons example is correct in it's detail though not exactly like what my friend does and fletchthai I believe you see more risk in the startegy than exists. It's a pretty conservative strategy. As PCA noted he does indeed have some insight into the nuances of the stocks movement and to simplify I didn't give a complete representation of his approach. Together with writing the OTM near month expiry calls, he oftentimes marries it to a LEAP put position. It's only a little bit more sophisticated an approach and still pretty conservative. Obviously, it is not a passive approach however. He chose GE as he felt it was kind of a market proxy and for it's lack of volatility.

edit: additionally he is a student of Hurst cycles and thus uses a bit of timing discipline as well. Still, I doubt he devotes more than 10hours per month to it. He seldom has any stocks called away, but I see that as his biggest risk. Not for the cost differential in replacement, but for possible tax consequences if he should get in a ST versus LT capital gain situation or wash sale situation.

Edited October 26, 2007 by lannarebirth

[PCA]

why should he get exercised, this is the very exception to happen. If prices move up too fast he simply writes a higher strike. Beyond that after playing GE for a few years he knows the anatomy of the stock and most likely will not blindly doing always the same. Its an excellent and save way to generate income but you need to tie up quite a large amount of money.

Well, if the option expires in the money then it *will* be exercised.

Prior to the expiry , if he wants to roll it to a higher strike then he has to buy back the first one - and then you are getting into the realms of rebalancing your gamma. Another example:

Price today = $100

Write a 3 month $105 call, receive $4

Price tomorrow: 110

Write a 3 month $115 call, receive $4

AND buy back the $105 call which is now in the money with a price around $11

Price on expiry date = $100 again

Net Net: Receive $8 in option premium, pay $11 for the 105 call

No gain or loss on the share. Result: not so good; it would have been better to have kept the short 105 call.

This is the problem of being short volatility (short gamma). When you have a short option position and the underlying share exhibits a lot of volatility you can have substantial losses. Short option sellers want low volatility. On the other hand people who own options (long volatility/gamma) are hoping for an increase in volatility.

the way you illustrated it is quite extreme and what short option sellers want is high volatility, not low. Beyond that he doesnt have to buy back the initially sold calls when he adds shorts of another strike. He is hedged in the stock and doesnt sell naked. A delicate strategy for stocks like GE but a shot in the pocket for stocks like GOOG or AAPL.

This can be made much more profitable and complex by creating a fence around the stock price playing volatility and time decay though I guess thats not really interesting to discuss it here.

[sonicdragon]

why should he get exercised, this is the very exception to happen. If prices move up too fast he simply writes a higher strike. Beyond that after playing GE for a few years he knows the anatomy of the stock and most likely will not blindly doing always the same. Its an excellent and save way to generate income but you need to tie up quite a large amount of money.

Well, if the option expires in the money then it *will* be exercised.

Prior to the expiry , if he wants to roll it to a higher strike then he has to buy back the first one - and then you are getting into the realms of rebalancing your gamma. Another example:

Price today = $100

Write a 3 month $105 call, receive $4

Price tomorrow: 110

Write a 3 month $115 call, receive $4

AND buy back the $105 call which is now in the money with a price around $11

Price on expiry date = $100 again

Net Net: Receive $8 in option premium, pay $11 for the 105 call

No gain or loss on the share. Result: not so good; it would have been better to have kept the short 105 call.

This is the problem of being short volatility (short gamma). When you have a short option position and the underlying share exhibits a lot of volatility you can have substantial losses. Short option sellers want low volatility. On the other hand people who own options (long volatility/gamma) are hoping for an increase in volatility.

the way you illustrated it is quite extreme and what short option sellers want is high volatility, not low. Beyond that he doesnt have to buy back the initially sold calls when he adds shorts of another strike. He is hedged in the stock and doesnt sell naked. A delicate strategy for stocks like GE but a shot in the pocket for stocks like GOOG or AAPL.

This can be made much more profitable and complex by creating a fence around the stock price playing volatility and time decay though I guess thats not really interesting to discuss it here.

Selling a higher strike, while already short the lower strike against the long position in the shares just makes you naked short the options, which not only is very risky but would also require margin to be posted, and would no longer be a cover call position. It would be a coverd call plus a short call. And you would still have downside risk on the shares.

The last thing option sellers want is high volatility. I think you are talking about implied volatility - where the higher the IV the bigger is the option premium taken in. I am talking about the problem when actual vol is greater than implied vol - this is the ruin of short option positions.

Edited October 26, 2007 by sonicdragon

[lannarebirth]

Sorry I was away and unable to respond. sonicdragons example is correct in it's detail though not exactly like what my friend does and fletchthai I believe you see more risk in the startegy than exists. It's a pretty conservative strategy. As PCA noted he does indeed have some insight into the nuances of the stocks movement and to simplify I didn't give a complete representation of his approach. Together with writing the OTM near month expiry calls, he oftentimes marries it to a LEAP put position. It's only a little bit more sophisticated an approach and still pretty conservative. Obviously, it is not a passive approach however. He chose GE as he felt it was kind of a market proxy and for it's lack of volatility.

edit: additionally he is a student of Hurst cycles and thus uses a bit of timing discipline as well. Still, I doubt he devotes more than 10hours per month to it. He seldom has any stocks called away, but I see that as his biggest risk. Not for the cost differential in replacement, but for possible tax consequences if he should get in a ST versus LT capital gain situation or wash sale situation.

Actually, I didn't explain that correctly. the near month calls married to LEAP puts is a seperate strategy and not part of the covered call strategy, wherebu he owns the underlying stock. sorry for the confusion.

[fletchsmile]

Fletch, I won't bother to requote the the whole of the last post as it is very long and detracts from readability.

In your example you said "i.e loss of 5 vs only 1% premium". Where does the loss of 5 comes from ? What is the market price at the start of your example when the option is sold and the writer received his/her 1% premium ?

I'll re-iterate what I said above: the risk in a covered call position is a fall in price, not a rise. A rise in price is not a risk because there will always be a time value in the option price in addition to intrinsic value, and so writing a covered call simply puts a cap on the potential upside. The option writer has given up some of the potential upside in return for some current income. However the downside risk still remains.

If there was risk on the upside, then covered call writers would be required to post margin; however they are not required to do so.

I guess this is where terms sheets come in handy

I was comparing on an incremental basis covered call vs simply holding a position in the stock, which was my original post, saying I'd be interested in the diff between this strategy and simple long position.

Would be interesting to compare his returns vs a simple long position. Presumably sometimes the calls are exercised against him, and he then has to repurchase, which will attract transaction costs as well as subject him to price fluctuations between settlement dates.

Because I was comparing incrementals that's why I ignored initial share starting share price, as it is common to both the long only position and covered call, so no need to consider for incremental

The way I read Lannarebirth's post was it was as an "overwrite". i.e the shares are held from a previous purchase and then writing a call option. I was then evaluating the difference in holding the share vs. holding it and then selling an option against it. Your example is a "buy write" and looking at the simultaneous purchase of stock and sale of option as a package, and evaluating the package in isolation as to whether it is profitable as a package. Hence the diff in perspective

eg Start price 95, strike price 100, market price at expiry 105. Premium 1.

A) Hold long position only: share price rises 10. Gain = 10

B ) Hold long positions in share and write a call > (1) share price gain again of 10 (2) option premium gain of 1 and (3) buyer of call pays 100 for 105 valued security, i.e loss of 5. Net of B ) = 10+1-5 =6.

Hence on an incremental basis compared to simply holding the long position he makes a gain of 10 compared to 6 with the covered call. If start price is 90 then it is 15 vs 15+1-5, i.e 11. If start price is 80 then its 25 vs 21. In each case the diff is 5 (gain in MV vs strike) -1 , i.e incremental loss of 4. That's why I didn't bother to quote the starting price, as on incremental it's irrelevant.

From an incremental perspective, comparing A) Long underlying only vs B ) long + written call, if the share price falls the loss in share price is the same on both for share price but in B ) has the premium income.

Put another way. If he holds only the share he has all the upside of it. When he writes a call, he limits his upside. Comparing the two options on an incremental basis. If price rises it's better simply to have the long position only. If price falls you will be better off with the covered call as at least you have the option premium. For simple long position the green arrow just keeps rising

Profiles:

Long only:

Max loss: Substantial fall in share price

Max profit: Substantial rise in share price

Covered call:

Max loss: Substantial fall in share price (as above, no difference, except premium income makes this slightly more favourable than simple long)

Max profit: LIMITED (hence relatively vs. long only position is poor/worse off/loss making)

Upside if exercised call: premium received + diff share price and exercise price

Upside if call not exercised: premium + gains in stock value

Summary: Covered calls would be useful if you are neutral to bullish on a share. Main use would be if while bullish on the underlying stock, you feel range will move very little over the lifespan of the call.

Personally I'd rather simply hold a long position as I pick investments I'm bullish on long term, rather than neutral-bullish. In my view if I don't make as much as I could have done, because of limiting my gains thru derivatives, I look at this as an opportunity loss or relative loss.

Not sure if that better explains my point. It probably answers Lannarebirth's tho' as why more people don't do it.

Edited October 26, 2007 by fletchthai68

[sonicdragon]

Sorry I was away and unable to respond. sonicdragons example is correct in it's detail though not exactly like what my friend does and fletchthai I believe you see more risk in the startegy than exists. It's a pretty conservative strategy. As PCA noted he does indeed have some insight into the nuances of the stocks movement and to simplify I didn't give a complete representation of his approach. Together with writing the OTM near month expiry calls, he oftentimes marries it to a LEAP put position. It's only a little bit more sophisticated an approach and still pretty conservative. Obviously, it is not a passive approach however. He chose GE as he felt it was kind of a market proxy and for it's lack of volatility.

edit: additionally he is a student of Hurst cycles and thus uses a bit of timing discipline as well. Still, I doubt he devotes more than 10hours per month to it. He seldom has any stocks called away, but I see that as his biggest risk. Not for the cost differential in replacement, but for possible tax consequences if he should get in a ST versus LT capital gain situation or wash sale situation.

Actually, I didn't explain that correctly. the near month calls married to LEAP puts is a seperate strategy and not part of the covered call strategy, wherebu he owns the underlying stock. sorry for the confusion.

covered calls + leaps would be a kind of "fence" strategy mentioned in passing by PCA earlier....

I agree that regular covered call writing is a low risk strategy.

[PCA]

why should he get exercised, this is the very exception to happen. If prices move up too fast he simply writes a higher strike. Beyond that after playing GE for a few years he knows the anatomy of the stock and most likely will not blindly doing always the same. Its an excellent and save way to generate income but you need to tie up quite a large amount of money.

Well, if the option expires in the money then it *will* be exercised.

Prior to the expiry , if he wants to roll it to a higher strike then he has to buy back the first one - and then you are getting into the realms of rebalancing your gamma. Another example:

Price today = $100

Write a 3 month $105 call, receive $4

Price tomorrow: 110

Write a 3 month $115 call, receive $4

AND buy back the $105 call which is now in the money with a price around $11

Price on expiry date = $100 again

Net Net: Receive $8 in option premium, pay $11 for the 105 call

No gain or loss on the share. Result: not so good; it would have been better to have kept the short 105 call.

This is the problem of being short volatility (short gamma). When you have a short option position and the underlying share exhibits a lot of volatility you can have substantial losses. Short option sellers want low volatility. On the other hand people who own options (long volatility/gamma) are hoping for an increase in volatility.

the way you illustrated it is quite extreme and what short option sellers want is high volatility, not low. Beyond that he doesnt have to buy back the initially sold calls when he adds shorts of another strike. He is hedged in the stock and doesnt sell naked. A delicate strategy for stocks like GE but a shot in the pocket for stocks like GOOG or AAPL.

This can be made much more profitable and complex by creating a fence around the stock price playing volatility and time decay though I guess thats not really interesting to discuss it here.

Selling a higher strike, while already short the lower strike against the long position in the shares just makes you naked short the options, which not only is very risky but would also require margin to be posted, and would no longer be a cover call position. It would be a coverd call plus a short call. And you would still have downside risk on the shares.

The last thing option sellers want is high volatility. I think you are talking about implied volatility - where the higher the IV the bigger is the option premium taken in. I am talking about the problem when actual vol is greater than implied vol - this is the ruin of short option positions.

yeah was a misunderstanding, options sellers want high volatility when they enter and not when they hold.

I doubt that this guy playing GE is playing option sizes that his whole stock position is tied in. Therefore he will probably plan what impact certain scenarios will have on his account. Anyway there are so many things to consider or calculate that will not meet much interest to be discussed here.

[sonicdragon]

Fletch, the starting price is not irrelevent when you quote the loss of $5 in isolation from the gain of $10 on the stock, which is the error in your post #157. It is only irrelevent when you consider the two together (or "incrementally" as you now put it)

[fletchsmile]

I agree that regular covered call writing is a low risk strategy.

Low risk strategy, and unless done frequently with a share that has limited range then it will also be low reward. That's why I would be interested to know what he makes vs a simple long position. If you widen your risk definition to include opportunity risk it's actually quite high. Share price doubles, he makes very little. Same as putting cash in a bank account. Low risk. But if you compare to what you could be doing and what you are missing out on, it's actually high risk

[fletchsmile]

Fletch, the starting price is not irrelevent when you quote the loss of $5 in isolation from the gain of $10 on the stock, which is the error in your post #157. It is only irrelevent when you consider the two together (or "incrementally" as you now put it)

Totally agree. If you buy a coverage call and evaluate in isolation you are right. I was comparing the two together or incrementally. Hence starting point is irrelevant.

This gives the answer to the original question of why everybody isn't simply "collecting rent", which was the original point I was making, albeit not so clearly. Relative to a simple long position you lose out if the price rises significantly.

Edited October 26, 2007 by fletchthai68

[sonicdragon]

I agree that regular covered call writing is a low risk strategy.

Low risk strategy, and unless done frequently with a share that has limited range then it will also be low reward. That's why I would be interested to know what he makes vs a simple long position. If you widen your risk definition to include opportunity risk it's actually quite high. Share price doubles, he makes very little. Same as putting cash in a bank account. Low risk. But if you compare to what you could be doing and what you are missing out on, it's actually high risk

Low risk = Low reward is one of the fundamental tenets of finance. Risk is positively correlated with returns.

Covered call writing is not the same as putting cash in a bank account at all. The returns are much better (the risk is higher than bank deposits because of the downside market risks).

I'm sorry, but saying that it's high risk because of the opportunity cost of giving up the upside does not make any sense at all.

[sonicdragon]

Fletch, the starting price is not irrelevent when you quote the loss of $5 in isolation from the gain of $10 on the stock, which is the error in your post #157. It is only irrelevent when you consider the two together (or "incrementally" as you now put it)

Totally agree. If you buy a coverage call and evaluate in isolation you are right I was comparing the two together or incrementally. Hence starting point is irrelevant .

This gives the answer to the original question of why everybody isn't simply "collecting rent", which was the original point I was making, albeit not so clearly .

Collecting rent on a long position, by lending the stock, is a completely different thing, and I'm sure that anyone who is writing covered calls knows that. In fact there's no reason why you couldn't lend your stock out and write a covered call on it.

[fletchsmile]

I agree that regular covered call writing is a low risk strategy.

Low risk strategy, and unless done frequently with a share that has limited range then it will also be low reward. That's why I would be interested to know what he makes vs a simple long position. If you widen your risk definition to include opportunity risk it's actually quite high. Share price doubles, he makes very little. Same as putting cash in a bank account. Low risk. But if you compare to what you could be doing and what you are missing out on, it's actually high risk

Low risk = Low reward is one of the fundamental tenets of finance. Risk is positively correlated with returns.

Covered call writing is not the same as putting cash in a bank account at all. The returns are much better (the risk is higher than bank deposits because of the downside market risks).

I'm sorry, but saying that it's high risk because of the opportunity cost of giving up the upside does not make any sense at all.

Was trying to use cash to show the opportunity cost. Of course it's not exactly the same in terms of finacial instrument.

Simply put: price doubles. Which is better long position only or covered call? By writing a call on a position you already hold, you are risking missing out on significant share price increase.

Locking in a few% when you expect much more also does not make sense.

Edited October 26, 2007 by fletchthai68

[lannarebirth]

I agree that regular covered call writing is a low risk strategy.

Low risk strategy, and unless done frequently with a share that has limited range then it will also be low reward. That's why I would be interested to know what he makes vs a simple long position. If you widen your risk definition to include opportunity risk it's actually quite high. Share price doubles, he makes very little. Same as putting cash in a bank account. Low risk. But if you compare to what you could be doing and what you are missing out on, it's actually high risk

I told you what he was making. He is always long the stock, with whatever gain or loss that entails. Additional to that he gets a monthly dividend and 25%-30% / year writing calls on his underlying position. I think the stock is up like 100% in the past 5 years. he got all of that gain in addition to the income. None or few shares were ever called away. If they were he replaced them immediately.

[lannarebirth]

Fletch, the starting price is not irrelevent when you quote the loss of $5 in isolation from the gain of $10 on the stock, which is the error in your post #157. It is only irrelevent when you consider the two together (or "incrementally" as you now put it)

Totally agree. If you buy a coverage call and evaluate in isolation you are right I was comparing the two together or incrementally. Hence starting point is irrelevant .

This gives the answer to the original question of why everybody isn't simply "collecting rent", which was the original point I was making, albeit not so clearly .

Collecting rent on a long position, by lending the stock, is a completely different thing, and I'm sure that anyone who is writing covered calls knows that. In fact there's no reason why you couldn't lend your stock out and write a covered call on it.

I thought unless you took possession of the certificates, or expressly instructed your broker not to, that shares were always subject to lending to short sellers.

[sonicdragon]

I agree that regular covered call writing is a low risk strategy.

Low risk strategy, and unless done frequently with a share that has limited range then it will also be low reward. That's why I would be interested to know what he makes vs a simple long position. If you widen your risk definition to include opportunity risk it's actually quite high. Share price doubles, he makes very little. Same as putting cash in a bank account. Low risk. But if you compare to what you could be doing and what you are missing out on, it's actually high risk

Low risk = Low reward is one of the fundamental tenets of finance. Risk is positively correlated with returns.

Covered call writing is not the same as putting cash in a bank account at all. The returns are much better (the risk is higher than bank deposits because of the downside market risks).

I'm sorry, but saying that it's high risk because of the opportunity cost of giving up the upside does not make any sense at all.

Was trying to use cash to show the opportunity cost. Of course it's not exactly the same in terms of finacial instrument.

You said "Share price doubles, he makes very little. Same as putting cash in a bank account."

Simply put: price doubles. Which is better long position only or covered call? By writing a call on a position you already hold, you are risking missing out on significant share price increase.

With the benefit of hindsight, one can easily say such things, but ex-ante it is meaningless. By the same logic I could say that holding a stock instead of shorting it was high risk because it subsequently went down.

Locking in a few% when you expect much more also does not make sense.

I think it should be obvious that someone who expects the price to double will not write a covered call.

Edited October 26, 2007 by sonicdragon