Covered call writing and selling cash-secured puts involve both buying and selling of call and put options. We are dealing with two types of options as well as utilizing both long and short positions of each. When we factor in the major Greeks, it is important to understand the relationship between time to expiration, stock implied volatility and change in share price as they relate to option value. It can get confusing and so I created a user-friendly spreadsheet, the focus of this week’s blog article.
Major Greeks when selling options
The three major factors that influence our option value are time to expiration measured by Theta, volatility of the underlying security measured by Vega and change in price of the security measured by Delta:
Theta measures the decline in option value for every calendar day that passes. Since we are selling decaying assets (options), Theta will work in our favor as the time value decreases as a result of Theta and it will cost less to buy back the options, all other factors remaining constant. We factor in Theta when deciding on the time frame for our option contracts (I favor 1-month options).
Vega determines the change in option value for every 1% change in implied volatility of the underlying security as calculated by an option-pricing model. High-Vega options generate higher option returns but also subject the option-seller to greater risk so we must find a comfort level that fits both our return goals and our personal risk-tolerance.
Delta is the Greek that calculates the change in option price for every $1.00 change in share value. The deeper in-the-money the strike, the higher the Delta and the more downside protection afforded to us in the form of intrinsic value. Here is a breakdown of Deltas as they relate to covered call risk:
- 0: Most aggressive (deep out-of-the-money)
- .50: Moderately aggressive (at-the-money)
- 1.00: Most conservative (deep in-the-money)
The major Greeks impact our positions in different ways depending on whether we are long or short the option and if we are dealing with calls or puts. The spreadsheet below is a quick-reference guide that highlights the impact of the major Greeks in each of these potential perspectives:
For more information on the option Greeks click here:
It is critical to understand the major Greeks and the factors that influence option value. This skill must apply to both call and put options as well as long and short positions. It’s my hope that this spreadsheet will serve as a useful tool in the investment arsenal of our members.
Department of Labor ruling on covered call writing in self-directed IRAs
The DOL has ruled favorably regarding the continued use of covered call writing in our sheltered or self-directed IRA accounts. This represents a tremendous victory for educated retail investors who can continue to take advantage of this conservative option-selling strategy which allows us to enhance portfolio returns without tax concerns. Great job by the DOL and all those who were involved in crafting this decision. BCI will continue to monitor political and legal issues that impact our retail investor community.
Stock Traders Expo: Marriott Marquis Hotel NYC: Short video:
Global stocks declined slightly this week, with a sudden rise in Japan’s yen negatively impacting markets. The Chicago Board Options Exchange Volatility Index (VIX) was unchanged on the week at 15.36. West Texas Intermediate crude prices rose to $39.23 from $36.82 a week ago, and global Brent crude prices rose to $41.12 from $38.73 on hopes of an agreement on production caps among oil producing nations later this month. This week’s reports and international news of import:
- In response to recent comments from presidential candidate Donald Trump, US Federal Reserve Chair Janet Yellen said that the US economy is still healing from the financial crisis and is not a bubble economy. She does not see evidence of imbalances, such as clearly overvalued asset prices, and noted that the labor market is improving
- Despite the introduction of negative interest rates by the Bank of Japan at the end of January, the Japanese yen has risen roughly 10% versus the dollar so far this year, including a 3% gain this week. Finance minister Taro Aso warned that the government would take steps to counter one-sided moves in currency markets, calling the sharp appreciation “undesirable.”
- Dutch voters rejected a trade and political agreement between the European Union and Ukraine earlier this week. The deal had already been approved by the parliaments of the 27 other members of the EU, The Dutch referendum was nonbinding, so it should not derail the pact’s implementation, but it does show signs of strain between the EU and its member states. This bears watching
- On Tuesday, the US government imposed new rules designed to make it more difficult for US companies to combine with firms in other countries to reduce their tax liability. The rule had an immediate impact, with US-based Pfizer and Irish-domiciled Allergan calling off a pending $160 billion merger after the rule was released
- The US Department of Labor finalized rules that will require financial advisors handling individual retirement accounts and 401(k)s to act as a fiduciary to their clients. Previously, advisors had been subject to a less-stringent suitability requirement. The broader definition of fiduciary will take effect in April 2017, with full implementation of the rule to begin January 1, 2018 (more on this above)
- The US Department of Education reports that 43% of borrowers from the government’s main student loan program are not making payments or have fallen behind. That’s a slight improvement from a year ago, when the figure stood at 46%
- After reaching an agreement with outstanding creditors earlier this year, Argentina is preparing to return to the bond market for the first time since 2001 with a $12.5 billion offering next week. The proceeds of the offering are expected to be used to pay back holders of the country’s defaulted debt
- An impeachment committee of Brazil’s congress released a report recommending members vote for a Senate trial to impeach President Dilma Rousseff
- Minutes of the March meeting of the Federal Open Market Committee (FOMC) suggest that rate hikes will come slowly until the global economy picks up steam. The FOMC discussed the possibility of hiking rates at its April meeting but said such a move would signal a sense of urgency that the committee did not think was appropriate
- Governor Alejandro Garcia Padilla of Puerto Rico signed a one-year government debt moratorium into law. The move buys time for the island’s government to deal with its debt crisis while it awaits help from the US
- India’s central bank lowered its repo rate 0.25% to 6.5%, the lowest level in five years
- In March, foreign exchange reserves edged up in China for the first time in five months, a sign of stability after months of heavy outflows. Reserves rose $10.26 billion to $3.213 trillion
THE WEEK AHEAD
- China releases its March consumer price index on Monday, April 11th
- China reports its March trade balance on Wednesday, April 13th
- US retails sales figures are released on Wednesday, April 13th
- The Bank of Canada monetary policy committee meets to set interest rates on Wednesday, April 13th
- The Bank of England monetary policy committee meets to set interest rates on Thursday, April 14th
- China releases retail sales, industrial production and gross domestic product on Friday, April 15th
For the week, the S&P 500 declined by 1.21% for a year-to-date return of 0.18%.
IBD: Uptrend under pressure
GMI: 5/6- Buy signal since market close of March 2nd
BCI: Moderately bullish, favoring out-of-the-money strikes 2-to-1. I am anticipating a positive earnings season due to muted guidance from last quarter.
Wishing you the best in investing,