“Covered call writing and put-selling are exactly the same strategies” Now you haven’t heard that from me but we have all heard it often enough to wonder why so many believe this. The main reason, the theory goes, is that the risk-reward profiles for both strategies are precisely the same and so that means that the strategies as a whole must be clones. In my humble opinion, they are related, cousins, if you will, not identical twins. In my fifth book, Selling Cash-Secured Puts, I devoted Chapter 15 to this topic, comparing the two strategies, with a comparison chart on page 214. This chart includes both similarities and differences. Whether we are writing covered calls or selling puts, our nemesis is the decline in share price. In both strategies if share price remains the same, rises or declines slightly, we win. We only can lose when share price declines significantly. This computes to more than the call premium or more than the out-of-the-money strike minus the put premium, depending on which strategy is being employed. In this article we will hone on these worst case scenarios and how the inverse impact Delta has on our exit strategy execution for declining stock prices in both strategies.
We will view a 3-month chart for Staples ((NASDAQ: SPLS) from September, 2015 through November, 2015:
Note the following SPLS price points:
- October 7th: $12.50
- November 3rd: $13.25
- November 16th: 12.60
Exit strategy requirement for a declining stock
The BCI methodology stresses the importance of remaining pro-active during the contract, buying back the options when opportunities arise for mitigation of losses or enhancement of gains. Since we are focusing on worst case scenarios, let’s view the option charts for the $12.00 in-the-money call option (lower than current market value) and the $12.00 out-of-the-money put option (also lower than current market value):
It is clear from this comparison chart that Delta has an inverse impact on call and put options and frequently can overcome the effect of Theta (time value erosion). In this example, the stock price declined from November 3rd to the 16th of November, a week before expiration (November 20th). If we needed to buy back the option the week prior to contract expiration, it would have been less costly for covered call writing than put-selling because of the impact of Delta on our option premiums.
Covered call writing and selling cash-secured puts are similar strategies but have several nuances that also make them different. The inverse relationship that Delta has on option premiums for the two strategies and that impact on exit strategy execution is one such example.
Panel discussion with Alan and experts from the Options Industry Council (Free)
For our members who missed this event, I was invited to participate in a discussion of option basics with experts from the OIC. Below is a link to the event. Just fill in the required fields and you’re in. I was also interviewed by the OIC in a separate taping and will provide that link to you once I receive it. Here’s the link to the panel discussion:
Upcoming live appearance
New York Stock Traders Expo
February 21st – 23rd
Marriott Marquis Hotel, NYC
Global markets rebounded late in the week as the Bank of Japan endorsed a negative interest rate policy. Markets seem to be pricing in expectations for additional action from the European Central Bank in March and a more gradual Fed rate-hiking implementation here in the US. Market volatility, as measured by the Chicago Board Options Exchange Volatility Index (VIX) declined to 20.5 late Friday from 23.5 a week ago. This week’s reports:
- The US economy grew at a modest 0.7% annual rate in the fourth quarter of 2015, reflecting the impact of a strong US dollar, modest global demand and an inventory surplus. Growth slowed from a 2% rate in the third quarter
- For the full year, GDP rose 2.4%, matching 2014’s growth rate
- The Federal Open Market Committee left rates unchanged, as anticipated
- The outlook for future rate hikes is unclear as the Fed acknowledged
- The Fed, however, also pointed to sturdy labor markets in its statement.
- Prices for crude oil rebounded late in the week on rumors of a meeting between OPEC and Russia to discuss a production cut of around 5%
- Earnings season: Thus far, nearly 73% of the companies reporting in the S&P 500 Index have beaten expectations and 47.4% of companies reporting have beaten revenue predictions
For the week, the S&P 500 rose by 1.75% for a year-to-date return of – 5.07%.
IBD: Market in confirmed uptrend
GMI: 0/6- Sell signal since market close of December 10, 2015
BCI: 1/3 of my stock investment portfolio remains in cash short-term. Favoring only deep out-of-the-money puts and in-the-money calls on active positions. Although the market is showing signs of a bottom as focus moves to corporate earnings, a bottom is not confirmed in my view. Caution remains a focus in my current investment portfolio probably at least through the February contracts. Plan to get more aggressive when markets calm perhaps for the March contracts.