Stop Holding Covered Calls to Expiration. Do This Instead. — Transcript

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1. 0:00I want to start off the basics. Let's
2. 0:01talk about equity investors that are
3. 0:03selling covered calls on the positions
4. 0:04they own and cash secured puts to
5. 0:06potentially buy those stocks. And I'm
6. 0:09mostly curious talking about expiration
7. 0:11dates and days to expiration and strike
8. 0:14prices. Specifically, if you're using
9. 0:16Delta, if you're using another metric to
10. 0:18determine
11. 0:19your strike prices. And then any notes
12. 0:21that you have or any
13. 0:23any um
14. 0:24notes that you have regarding when do
15. 0:26you generally enter, when do you want to
16. 0:28generally exit? And like I said, we're
17. 0:30going to take notes for you guys so that
18. 0:32you don't have to and we'll share the
19. 0:33notes with you guys afterwards.
20. 0:35>> And I will tell you Tony that I'm very
21. 0:39I'm I'm I have an optimal set of
22. 0:41mechanics that we use. And so I will be
23. 0:44very precise. There'll be nothing
24. 0:45wishy-washy in this. So so your
25. 0:49your clients and and your listeners are
26. 0:52going to be
27. 0:53they're going to get an answer. There's
28. 0:55not They're not going to leave this
29. 0:56session today
30. 0:58and and say, "Hey, hey, hey, I don't
31. 0:59like the way he beat around the bush. I
32. 1:01don't I don't like I don't like
33. 1:02generalizations." I'm going to give you
34. 1:04optimal mechanics based on
35. 1:07not we we built a think tank 9 years
36. 1:10ago, 2011. We're going into our 10th
37. 1:12year. Um we've done I I want to say
38. 1:15almost 11,000 pieces of research on all
39. 1:18these topics. So we beat this to to a
40. 1:22pulp and I feel pretty confident, you
41. 1:24know, in the research. Now, most of the
42. 1:25time we use spies as our generally as
43. 1:27our underlying because of, you know, the
44. 1:29broad-based market. We have looked at
45. 1:31obviously lots of other things in
46. 1:32addition to spies, but if you were going
47. 1:34to generalize on a certain underlying,
48. 1:36we would use the S&P 500, okay?
49. 1:39>> Okay.
50. 1:40So let's talk about covered calls,
51. 1:42right? Where do you start in terms of
52. 1:43dates to expiration and let's strike
53. 1:46price. Let's let's start with that.
54. 1:48>> Ideally for covered calls, you want to
55. 1:49be There's no difference in virtually
56. 1:52any of the dates that we're going to
57. 1:53talk about today except for things that
58. 1:55have a binary event like an trade. So,
59. 1:57when we're talking about covered calls,
60. 1:59you are looking at a the optimal time
61. 2:02frame is 45 days. So, anything from 35
62. 2:05to 60 would fit in our time range, but
63. 2:08optimally, we're talking about 45 days.
64. 2:11>> And how would you select your strike
65. 2:12prices on a covered call? And if do they
66. 2:15differ when you're selecting strike
67. 2:16prices for a cash secured put?
68. 2:18>> Um they they differ slightly, but not
69. 2:21very much. Now, here's the difference.
70. 2:23The difference between a cash secured
71. 2:24put and a covered call is the cash
72. 2:27secured put has a slightly higher or or
73. 2:29just a short put. It doesn't have even
74. 2:30have to be cash secured. It can be
75. 2:31either a short put or a cash secured
76. 2:33put. Um the cash secured put has a
77. 2:35slightly higher probability of profit,
78. 2:38and the covered call has the potential
79. 2:39to make a little bit more money because
80. 2:41you're using two different strikes. But,
81. 2:43generally speaking,
82. 2:45um generally speaking on covered calls,
83. 2:47you're going to sell the out of the
84. 2:49money
85. 2:5030 or 35 delta call.
86. 2:52So, you're never going to sell an at the
87. 2:54money, you're never going to sell an in
88. 2:55the money. You're going to sell an out
89. 2:56of the money 30 or 35 delta call. Now,
90. 2:59sometimes the reason it's a little bit
91. 3:00different is sometimes, you know, the
92. 3:02strikes are a little wider, but 30 35
93. 3:04delta call, 45 days to expiration,
94. 3:07you're going to do it as a single trade,
95. 3:08no legging, because when you're doing
96. 3:10covered calls, unless you already own
97. 3:11the stock, there's no reason to take leg
98. 3:13risk. And so, you do it as a single
99. 3:15trade. All the brokerage platforms in
100. 3:17America support it as a single as a
101. 3:19single as a single order. And um
102. 3:23uh the only other thing I would mention
103. 3:25is our mechanics suggest that you would
104. 3:28prefer in a perfect world, you'd prefer
105. 3:31high IVR and low basis. Low basis means
106. 3:34low price high IVR.
107. 3:37>> So, let me ask you this. What are you
108. 3:40What are you optimizing for when you say
109. 3:42that 35 30 to 35 delta? Are you looking
110. 3:45for the highest possible return on that,
111. 3:48or are you looking for, for example, you
112. 3:51know, when you're selling a covered
113. 3:52call, a lot of investors want to sell a
114. 3:53covered call with a fairly low risk of
115. 3:56losing that stock. So, I'm curious as to
116. 3:58kind of what parameters you're
117. 3:59optimizing around.
118. 4:00>> You're optimizing on the statistical
119. 4:03chance of the greatest number of dollars
120. 4:05per day. So, with the least amount of
121. 4:08gamma risk and the least amount of
122. 4:09exercise risk.
123. 4:11>> Okay.
124. 4:11>> So, essentially, there's a Now, we we
125. 4:14should we should be very clear about
126. 4:16this. A covered call is a bullish
127. 4:18position. So, you want the stock to go
128. 4:20higher. So, you want your call to be
129. 4:22challenged. There's no situation where
130. 4:24you do a covered call where you want the
131. 4:25stock to go lower just to keep the call
132. 4:27premium. That's not what you want. You
133. 4:29actually want the stock to go higher.
134. 4:30Now, if you're nervous about, you know,
135. 4:32no matter what, you don't want a tax
136. 4:34consequence for the stock getting called
137. 4:35away, either sell a lower delta call,
138. 4:38like a 20 or 25 delta call, and manage
139. 4:41the trade early. The key to covered
140. 4:42calls, and this is the mistake that most
141. 4:44people make, is they hold on to it or
142. 4:46try to hold on to its expiration. The
143. 4:48key to covered calls is whatever your
144. 4:50duration is, you manage it at 1/2 the
145. 4:53duration, or preferably around 21 days
146. 4:55to go to expiration, because that way
147. 4:57you have the lowest gamma risk and the
148. 4:59highest return per day. Your return on
149. 5:02capital, or your return for the premium
150. 5:05that you sold on a per day basis, is
151. 5:07almost 20 to 25% higher if you manage
152. 5:10the trade about 2 to 3 weeks before
153. 5:12expiration.
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