Covered Calls Income Strategy.
What a horrible end to the week! Friday was absolutely dismal, but we will get to that later. First, let’s go through the other ‘income’ option strategies that are quite fashionable at the moment.
How Covered Calls Work
Covered calls are touted as a great way to create an income on the stock market. A covered call is where you hold the stock and then sell calls against it. You collect the premium immediately (and you never have to give it back). If the option expires ITM then you have to sell your shares at the strike price (and buy it back before you can do the strategy again) , if it expires OTM then you will keep the shares.
You need a lot of capital
Let’s say you have 10 SPY shares worth $5,858 and you want to implement this strategy. Unfortunately, you are out of luck because you don’t have enough shares to sell a call against.
Because options deal in contracts of 100 you need 100 shares before you can implement this strategy. So your account has to be 10 times bigger!
Real-life returns
Let’s say you have 100 SPY shares, and they are worth $58,580 as SPY is trading at $585.75. Let’s say that you want a weekly income, so you are going to sell a weekly call option at open every Monday which expires 5 days later on Friday.
Looking at the 22 November 18, 2024 chain here are your choices:
You miss out on big rises
What you must remember is that you are giving up a large part of the gains in SPY (or any share) in return for the weekly income. If you are exercised, then you have to sell at the strike even though the stock is trading above it. You then buy your stock back at the higher price, possible causing a loss on the transaction.
Being exercised
How often would you be exercised? That depends on how high you set the strike of the option you are selling. The table below shows SPY weekly gains.
So if you went for the 1% above strike (which is the only one that gives a decent return (16%)) then there are 16 times that you are missing out on SPY gains, and some of these weekly gains are quite large. Remember, you have to buy back at the higher price, so you can see that this strategy can easily turn into a loss-maker.
Picking Cherries
However, that doesn’t stop people writing books about it, and financial planners recommending it. You can always cherry-pick a situation where it worked as an example, but you can’t do it consistently.
I really doubt that any of the many who are promoting this strategy have ever actually traded it!
Harsh, I know, but you would be surprised at the number of people who write books & newsletters about trading but who don’t actually trade themselves.
Covered Calls Against Options
If you have a DITM call options, then it is possible to write a call against that as long as it has a higher strike. So, for example, let’s say you have a 50% strike ($300) SPY option you can sell the above options. Your portfolio would be worth less (as the options would be worth around $290) and so your returns would be double those stated above.
But you still have to deal with the fact that this could be a losing strategy as you are giving up many of the gains from SPY rising, and have to buy back SPY at a higher price.
The Wheel Options Strategy
The options wheel is very trendy, and there are several books that have a high profile. This is how it works:
Actually, I have just decided to keep this until next week as the blog will be too long if I continue.
To the markets . .
Good news is bad news again.
Federal Reserve chairman Jerome Powell said that because of economic growth being strong, a solid job market, economic growth over 3%, and inflation at 2.3% (2.8% ‘core’) which is above his 2% ideal that there was ‘no rush to lower interest rates’.
And so, on Friday the market tanked. Big time. Not nice.
It is hard to escape the feeling that his speech is at least in part to the political situation. Trump appointed Powell in 2018, and his term expires in May 2026. Trump considered dismissing him during his first term, presumably because he would not accommodate a looser monetary policy. Powell said at the time that he would fight his removal through the courts. He has said recently that he would refuse to leave the office even if ordered by Trump, and said that legally it can’t be done. Link to Reuters.
I have tried not to talk about politics in this blog, but the Fed has such a big influence on the market I don’t think we can ignore it. If you want to read his speech here is the link.
The other headline I saw was that Warren Buffett has turned bearish and is warning investors to get out of the market. I haven’t had time to read exactly what we said, or work out why he said it, I will do by next week’s blog.
SPY Charts
Sometimes I hate being right. Like now. In last week’s blog I said:
Since then, SPY has been trading above this level ($585) and it is likely that at some stage it will come down to it and test it for support – especially as it is approaching the $600 level,
Well, SPY did exactly that. Friday 8 November it was nudging the $600 level, but then in the next 5 days it dropped every day until it got down to $585.
I know that there is a widely-held belief that the market is random, and you can’t predict it. I beg to differ.
You definitely can’t predict it all the time, but based on what you have observed happening in the past you can make a jolly good guess, with the odds on your side. Not convinced? Just check last week’s blog to check that I actually said it before it happened.
It is easier to see it on the chart. The last 5 candles are all red and start with the open on Monday at the $600 level (green line) , then dropping to the $585 level (maroon line, previous high in October) and closing on it on Friday. Spooky?
Looking at in on the longer term chart we see that it is dropping back to the uptrend which is still intact.
SPYG Charts
The SPYG chart isn’t quite as perfect as SPY, but it’s close. The support / resistance line (top pink) is the high it reached in early October, which was slightly above the high that it reached in July (blue). Like SPY it has retreated from its all time high and is testing support at $85.
On the long term chart we see that the uptrend is still in place.
QQQ Charts
Unfortunately, QQQ is now trading below its all-time high in July (green), and is below $500. It may drop to the next support / resistance level at $485, we shall soon find out!
On the weekly chart it has dropped back to the bottom of its trading channel.
VIX Charts (Volatility)
The VIX chart has not really popped up, and is comfortably below the 20 level (low volatility)
ITMeter
The week ahead . .
Nvidia reports on Wednesday, and is creating a buzz. Some analysts are predicting a jump in revenue and the continuation of the AI boom, and of course there are more than a few Jeremiahs out there forecasting doom and gloom.
The Fed aren’t meeting again until December 17 – 18, although the minutes of the 6-7 November meeting will be published on the 27th November, and can cause some volatility.
Earning season is coming to a close, with Walmart, Target, Lowes and John Deere scheduled to report this week.
The futures
The futures are up a bit, mainly in the Nasdaq (presumably traders anticipating NVDA results). It is still 8 hours until market open.
Fingers crossed for a good week!
Heather
25 Responses
Hi Heather, I came across your 2023 blog post about the ITM notification update. I’m really interested in staying informed about any new updates from you. Could you please sign me up to receive notifications as soon as you post something new? Also, I wanted to thank you for all your hard work and dedication to your books and blogs. Thank you Denis
HI Denis – thank you!
You are on the list and you should get an email every Monday before the market opens. The next one will be in3 days’ time so let me know if you don’t get it.
h
Hi Heather;
I loved both of your ITM books and their strategies: Can you also sign me up for the updates? Thank you!
Hi Joe, thank you for your kind words!
You are on the datanbase now and should get an email every Monday before market open notifying you.
h
Selling weekly options puts has provided me with an amazing amount of weekly income when the underlying stock has increased gradually, or has gone sideways. I generally avoid naked puts, have a few, but usually buy a longer term protective put for protection on each trade to limit any losses.
When the underlying stock goes down a loss will occur. At that point you need to decide to whether to continue writing puts , or in some cases selling the protective put and exiting the trade. If assigned stock, one can sell the stock and continue writing puts for the next week. Or, in some case retain the stock to see if it rebounds and/or sell a covered call. I’m not in love with covered calls.
Hi JOhn – great that it has been working for you, well done.
You are actually doing it on stocks, not indexes? I seem to have a terrible touch with stocks, to me they are so unpredictable. I think it is because they depend on the company so much, whereas an index like SPY relies mostly on the human element, just a mass of people, hence more predictable.
But great that it works for you.
Do you fancy a spot on the blog where we can follow along with what you are doing?
Let me know, I can set up a separate page.
h
Hi Heather,
Thanks for the offer and it’s so nice for you to take time to reply.
I’ll pass on the offer to have a separate page illustrating my selling weekly puts trades. However, FYI, during the middle of each week, I seek stock evaluations or ratings for trades on IBD, Barchart, Market Edge. Motley Fool, Zacks, and finally Morningstar for its take on fair value estimates.
Trade are executed on Thursdays or Fridays selling weekly puts while considering the stocks with the greatest number of consensus positive ratings, keeping in mind earnings dates announcements, bid/ask prices, Implied Volatility, Deltas, along with a short prayer.
I’m experimenting with ETF’s based on the eleven sectors, but may in the future experiment with other momentum ETF’s because the XLF’S AND XLC’S
of the world generate unattactively small premiums and are hardly worth the effort in my limited experience.
Finally, your weekly commentary on the market is valuable and intriguingly informative. Regards,
John 11/25/24
HI JOhn – sounds like a lot of work! Do keep us posted about how it is going.
h
HI JOhn – sounds like a lot of work! Do keep us posted about how it is going.
h
Dear Heather,
Thank you for your weekly blogs as always. Please keep in mind that the beauty of the ITM is its simplicity and staying in the market when there is a golden cross and staying on the sideline when there is a death cross. We should not be “Penny wise and pound foolish” and try to justify our own fancies thinking of different ways to extract a few more percentages of returns or several percentages while risking our capital and peace of mind.
Sincerely,
George Halongton
Hey George – you are right, simplicity is the key.
Peter Lynch got it right when he said:
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
h
Dear Heather,
Thank you for your reply. I really admire the ITM method due to its easy approach of trading and investing. There is no need to spend too much time looking at the stock market daily. We can spend more time focusing in our fitness, family, and finance.
Sincerely,
George Henry Halongton
Agree!! And travelling!
Hi Heather,
I am analyzing QQQ options with an expiration date of June 20, 2025, and noticed that some strikes are priced at $XXX.78 (e.g., $299.78). Are there any drawbacks or potential issues I should be aware of if I choose a DITM strike with this fractional pricing?
Thank you for your insights!
Denis
Hi Denis – those pesky options that are not nice round numbers are a pain, because it makes doing calcs in your head a bit difficult.
But it isn’t a problem – you will notice that they all end in .78, and this is because there is a special cash distribution – on March 10, 2023, the trust declared a special cash distribution of .78 per unit, but it was only applied to options with OI (open interest) on March 31st 2023. You may have noticed that after this date the strikes are completely normal.
Its a bit complicated and I could go on, but I think that what you are wanting to know is ‘is there any problem with these options with the funny strikes?’ and the answer is ‘no, they are perfectly legitimate, and will not cause a problem.’
Feel free to get back to me if you need more details.
h
Hi Heather,
Since you’re discussing
income strategies could you share your thoughts on iron condors?
Thanks!
HI Robert
I used to have a moderately successful method of doing iron condors on SPY & QQQ, but after a while the option pricing became cheaper so it wasn’t worth doing. It is probably time for a revisit, thank you for the idea!
h
I meant to add the following comment that I neglected to because of my lengthy praise of your previous call. I have never understood the logic of selling of calls or covered calls in a bull market or the selling of puts in a bear market. I f I do it, like I did in the past, I tried to primarily sell call spreads in a bear market, though you will not get much premium often in a bear market, unless you sell near the top and the same for selling puts or put spreads in reverse at or near the bottom of the bear market. I don’t even bother to try it anymore. I have never sold anything naked except in the Commodity markets when I was young, inexperienced, under capitalized and stupid.
Hey – we were all once young, inexperienced, undercapitalized and stupid.
What separates successful traders from others is that we didn’t give up, but kept taking it on the chin, and kept on learning – which you have obviously done as well! great comment.
h
There was no luck in your call last week. It shows your experience and comfort using Charts and understanding support and resistance, trend lines, trading channels and probably other well understood technical analysis concepts. There is no magic. I too have made calls and many have been right on and sometimes I think I am a genius and then the Market reaches out and slaps me in the face. I have been right on many calls but no one is ever perfect, particularly me. Keep up the good work. Wish I could post a Chart of mine that made me get very apprehensive leading into last week but I don’t think that would work on this format. Maybe I will see if it can be posted on your discussion board with explanation.
Hey Tommy – not saying in any way that I am infallable – certainly not!!
I often surprise myself because I am expecting to be wrong – the market loves to spank you.
If you want to email your chart to info@heathercullen.com with an explanation I would be happy to use it in next week’s blog.
h
Will do when I find the time. I made a big Error in my last post at the end where I wrote ever instead of never in regard to selling anything naked.
I will see if I can fix it.
Yes! It worked. (although i think that it was clear that it was a typo)
h
Thanks Heather, your comment on the vagaries of selling calls was pure gold!
Thank you Blake!