Covered Calls: The Popular Strategy, Often Lacking in Analysis
12/29/2015 8:00 am EST
For the benefit of any traders new to the realm of options and to clarify a misconception, Fred Oltarsh, at Options Strategy Network, cites a historical example to emphasize why he feels that selling covered calls is the exact same thing as selling puts.
People love covered calls. It’s a strategy that is talked about all of the time and frequently executed. However, the whole premise of the strategy is misunderstood by many traders managing their own portfolio. The worst analysis is when one says, “I love selling covered calls but I hate selling puts.” Selling covered calls is the exact same thing as selling puts. Once this concept is understood, the decision to sell covered calls is a bit more palatable. If one buys a stock and sells a call, they have sold a synthetic put. Keep that in mind when you implement the strategy.
The next aspect of covered calls worth analyzing is the skew of the option chain involved in the transaction. In most stocks and stock indices, there is a strong skew to the put side. This means that the implied volatility of the calls is substantially lower than that of the puts. As a historical example, the chart below shows November 11’s December option series in SPY with SPY trading—at the time—at 208.47. The implied volatility of the puts and calls is shown for each strike price. The implied volatility skew in the SPY was similar to that of many individual stocks and—given the tight market in SPY—was exceptionally good for analyzing strategies. We were essentially $4.50 from the $204 puts and the $213 calls. Note that the implied volatility for the puts was 16.34% while the implied volatility for the calls was 11.57%. In dollar value, the puts on the offer were 2.65 while the calls were 1.31. The disparity is significant and shows one how expensive it is—on a comparative basis—to sell covered calls. The question any trader should always ask is, am I getting good value for the trade I am establishing?
Selling covered calls is not the only way to gain some downside protection. At Options Strategy NetworkTM, our goal is to educate traders to initiate positions with the greatest success of profitability.
Options trading involves significant risk and is not suitable for every investor. The information is obtained from sources believed to be reliable, but is no way guaranteed. Past results are not indicative of future results.
By Fred Oltarsh, Proprietary Trader and Editor, Options Strategy Network