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Alex,
I used QQQ in the example simply for demonstration purposes, but in reality
I'd much prefer to sell the richest and deepest ITM stocks I can find,
almost regardless of the time to expiration. I like your idea of selling
half ITM and half OTM as a reasonable precautionary approach, but is that
really necessary if you are presumably diversified anyway?
A tool that I'm not able to find that I'm comfortable with is a premium
scanner, if you will. I've used Track Data's real-time scanner, and it works
quite well, but it's a career in its own right. It's still a DOS-based thing
(written around the time of the PC XT I think). It will consistently uncover
rich and deep where the premium is around 125% of theoretical value with
expiration in 60-90 days.
I'd venture to say that if one has 20+ such positions in a portfolio, the
probability of earning a well above average net profit (on the portfolio) is
about the highest I've experienced. That's not to say it's the most
profitable strategy, but it's clearly in the best return for the least risk
category.
Do you have any suggestions for a scanner?
Colin West
-----Original Message-----
From: Alex Matulich [mailto:alex@xxxxxxxxxxxxxx]
Sent: Wednesday, January 16, 2002 10:52 AM
To: cwest@xxxxxxxxxxxx
Cc: omega-list@xxxxxxxxxx
Subject: Re: please critique this strategy
I'm a bit late answering this but I have some experience in this matter.
Colin wrote:
>Not too long ago a probable and/or realistic annual return that could be
>expected was discussed on the list and I believe the consensus was that
not
>more than 40% p.a. could realistically be expected, barring excessive risk
>and an extraordinary "banner" year. I'm raising a strategy for discussion
>that has the potential to exceed 40% p.a. that also encompasses several
>"trading safely" features, if you will, and can usually support quite large
>fills with little slippage.
>
>The goal of the strategy is to sell rich covered call premiums that are
>deep-in-the money. In the example I've used QQQ and QQQFJ (Jun'02 36 call).
I'm doing something similar in my retirement account. However,
deep-ITM calls don't give you a good return compared to risk.
Whenever you're selling covered calls, you want high volatility and
high theta, meaning the premiums are high and they decay fast. The
optimum time for selling appears to be 25-35 days from expiration,
from my experience. This is a good thing because you can do your
trading once a month.
If you sell calls too near expiration, they don't have enough time
value left in them to make it worthwhile. If you sell calls too
far out, they don't decay quickly enough to compensate you for
volatility risk, and they don't have enough premium to compensate
you for the risk of a decline in the underlying price prior to
expiration. You're playing with the tail of a distribution here,
and the tail is fatter than a normal distribution, so you're
assuming more risk than a normal distribution would indicate, the
further away from expiration you go.
My strategy sells one OTM and one ITM call for 200 shares of a
stock (QQQ or others) during the week after the 3rd Friday of the
month. The OTM call gives you a bit of premium and room for 100
shares (half) of the stock to be profitable. The ITM call causes
a slightly better than break-even situation for the other half of
the stock (the amount lost by the stock from getting called away
will be offset by the option premium). The reason for doing the ITM
call is for insurance in case the stock declines below the lower
strike price, in which case you can adjust down your cost basis by a
significantly greater amount than if you just sold OTM calls. OTM
calls don't protect you from declines.
For QQQ, this strategy will give you a pretty consistent 30%
annualized return or more, based on my testing. You can get higher
returns with individual stocks, but there's also more risk. QQQ is
diversified.
--
,|___ Alex Matulich -- alex@xxxxxxxxxxxxxx
// +__> Director of Research and Development
// \
//___) Unicorn Research Corporation -- http://unicorn.us.com
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