Covered call writers and put-sellers are always looking for an edge. Some may wonder which option Delta would make the best option-selling candidate. Intuitively or from experience we know that at-the-money strikes (Deltas near 0.50) generate the highest initial returns. I’ve stated that over-and-over again in my books and DVDs. Can this be demonstrated mathematically (look out folks, I’m at it again!)? Today’s article will be an exercise, not a scientific study, to demonstrate the relationship between Delta and our time value initial profit generated when selling options. Our goal is to calculate the time value per unit of Delta for in-the-money, at-the-money and out-of-the-money strikes.
- Select a stock from our Premium Watch List: Smith & Wesson Hldg. (SWHC)
- View an options chain for in-the-money, near-the-money and out-of-the-money strikes
- Use the time value premium of each strike and a Greek Calculator to quantify the Delta for each strike
- Divide the time value by the Delta to calculate time value per unit of Delta
- The proposed formula is TV/Delta
Options chain for SWHC as of 1/13/2016
With SWHC trading at $20.93, we select the $20.00, $21.00 and $22.00 strikes which generate premiums of $1.70, $1.20 and $0.75 respectively. Now the $1.70 premium for the $20.00 strike consists of intrinsic and time value so we deduct the $0.93 of intrinsic value to get a time value of $0.77 for the $20.00 in-the-money strike (are we having fun so far?). The other two strikes are all time value.
Calculating Delta for the $20.00 in-the-money call
Delta = 0.6523
Calculating Delta for the $21.00 near-the-money call
Delta = 0.5215
Calculating Delta for the $22.00 out-of-the-money call
Delta = 0.3899
$20.00 strike: $0.77/0.6523 = $1.18 per unit of Delta
$21.00 strike: $1.20/0.5215 = $2.30 per unit of Delta
$22.00 strike: $0.75/0.3899 = $1.92 per unit of Delta
The $21.00 near-the-money strike generated the highest time value per unit of Delta while the in-the-money and out-of-the-money strikes were both lower. Deltas near 0.50 will generate the highest time values and that figure will decline as Delta moves to 0 or to 1.0. Although this exercise is not in the galaxy of a scientific experiment, I would expect, based on our knowledge of Delta and option premiums that this could be duplicated over-and-over again.
Lower Delta options should be favored in bear (in-the-money calls) and bull (out-of-the-money calls) markets based on the moneyness of the options. In these two scenarios we can take advantage of upside potential and downside protection afforded by these strikes. If we were convinced that the market is consolidating and trading sideways, high-Delta options may be more appropriate.
Blue Hour Webinar registration is now open to Premium Members
Registration for the July 28th Blue Hour webinar is now open to Premium Members only. This event is free to members. Once you are registered, you will receive instructions regarding how to attend this event and will be given an opportunity to submit a question.
To register, login to the member’s site and scroll down on the left side below the store discount link. Then click on the Blue Hour sign-up link and fill out the short registration form. For members who cannot attend the event live, my team will be recording the webinar and it will be posted on the member site the following week.
The BCI team and I are looking forward to providing this new educational tool to our members and happy to make this a free resource for our loyal members. On September 1st, there will be a rate increase for new members but you will be grandfathered into the current lower rates as long as membership remains uninterrupted.
Thank you for your loyal support over the years.
Alan and the BCI team
Next live event- Workshop
July 16, 2016
American Association of Individual Investors
Washington DC Chapter
Northern Virginia Community College
9 AM – 12:30 PM
2 Florida seminars just added
1 New York seminar just added
Long Island, NY 5/9/2017
Global were generally flat this week with continued Brexit fallout and concerns over the state of the Italian banking sector. Oil prices fell and The Chicago Board Options Exchange Volatility Index (VIX) declined to 13.23 from 15.16 last week. This week’s reports and international news of importance:
- May payrolls were revised lower, to 11,000 from 38,000 while June payrolls were far stronger than projected, rising 287,000, over 100,000 more than expected
- The economy averaged 149,000 new jobs per month in May and June, a figure that will give the FOMC more incentive to raising rates later this year
- With the Bank of England indicating last week that it will likely ease monetary policy over the summer, the pound extended its decline on the foreign exchange markets this week, falling to a 31-year low of $1.2780 on Wednesday and ending the week slightly below $1.3000
- Several open-ended funds investing in UK commercial real estate have been forced to halt redemptions and dramatically mark down their holdings as investors seek to withdraw funds
- Minutes of the June Federal Open Market Committee meeting released this week show that rate setters were in no rush to hike rates
- The committee also cited the uncertainty surrounding the Brexit referendum, which took place a week after the meeting, as a reason to hold rates steady
- Many Italian banks are saddled with crippling amounts of bad loans, but bailing them out with government money is not an option until bond holders first take a hit, according to European Union rules
THE WEEK AHEAD
- The Bank of Canada holds a rate-setting meeting on Wednesday, July 13th
- The US Federal Reserve releases its Beige Book on Wednesday, July 13th
- The Bank of England Monetary Policy Committee meets to set rates on Thursday, July 14th
- China releases gross domestic product and retail sales data on Friday, July 15th
- The US releases retail sales data and it’s Consumer Price Index on Friday, July 15th
For the 4-day week, the S&P 500 rose by 1.83% for a year-to-date return of +4.21%.
IBD: Market in confirmed uptrend
GMI: 6/6- Buy signal since market close of July 1, 2016
BCI: Moderately bullish. Currently hold no short option positions due to the Brexit situation but fully invested in stocks and ETFs. Pending market action this coming week, my plan is to favor out-of-the-money strikes for the August contracts.
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US