# Covered calls on Installment warrants



## bingk6 (10 March 2007)

Hi all,

Just about all brokers will allow covered calls to be written again FPO shares. Are there any brokers in Aust which allow covered calls to be written against Installment warrants ??


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## BradK (10 March 2007)

Freeman fox. 

Or a calendar bull spread for roughly the same result. 

Cheers
Brad


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## reece55 (10 March 2007)

bingk6 said:
			
		

> Hi all,
> 
> Just about all brokers will allow covered calls to be written again FPO shares. Are there any brokers in Aust which allow covered calls to be written against Installment warrants ??




bing

Have a look here:

http://www.asx.com.au/data/instalment_warrants_collateral.pdf

The answer to your question is yes and all brokers should allow this, because the collateral list is set by ACH, not the broker. When I started out, this is one of the strategies I used myself. Then I realised via an options payoff diagram that this was really like selling a naked put and selling a call a strike or two above it. Personally, I no longer employ this strategy - it makes money for an investment bank and gives you a lot of risk, for limited reward. 

If you had some warrants that you had deep profits on, this is another story and perhaps a sensible strategy...

Cheers


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## bingk6 (11 March 2007)

BradK said:
			
		

> Freeman fox.
> 
> Or a calendar bull spread for roughly the same result.
> 
> ...




I visited the freeman fox website and then clicked on the share trading link, which brought me to the Etrade website, which is the broker that I currently use. Unfortunately Etrade does not allow warrants as collateral for CCs (as far as I can see).


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## bingk6 (11 March 2007)

reece55 said:
			
		

> bing
> 
> Have a look here:
> 
> ...




Hi Reece,

Yes whilst all brokers should allow it, given its approval by ACH, my broker Etrade does not. Indeed, I find most brokers in Aust charge margin levels way above the ACH requirements, which greatly reduces the effectiveness of these strategies.



			
				reece55 said:
			
		

> bing
> 
> Then I realised via an options payoff diagram that this was really like selling a naked put and selling a call a strike or two above it.
> Cheers




Was hoping that you can explain this a little more. An installment warrant is really a long dated DITM call and the CC is a short term OTM call (by just 1 or 2 strikes), and the result (as far as I can see) is a diagonal Bull Call Spread, as Brad indicated. Where am I missing out ?


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## reece55 (24 March 2007)

bingk6 said:
			
		

> Hi Reece,
> 
> Yes whilst all brokers should allow it, given its approval by ACH, my broker Etrade does not. Indeed, I find most brokers in Aust charge margin levels way above the ACH requirements, which greatly reduces the effectiveness of these strategies.
> 
> ...




Hi Bing
Think I missed your query on this one, so having a browse through the derivatives section of ASF, thought I had better reply!

I guess this really depends what kind of warrant you are buying and how heavy the option you are selling is out of the money,etc , etc (how long is a piece of string)..... But essentially, what I am saying is that by purchasing the warrant and then selling the call option, you are leveraging the risk of a plain old covered call (not 100% however, because the warrants are not usually delta 1 which provides some minor protection). I am not (after having a go at these kind of strategies in the past) a big fan of such a strategy, as I found there were much easier ways of making money with better risk/reward ratios. If you still liked the leverage, you could still achieve this by buying a long dated call deep in the money and selling an OTM call close to expiry. Trust me, you will pay far less of a premium on the call option than you will on the warrant. My point here is that the warrant writers screw you with a much higher cost of the leverage than say an option or CFD will. Ever tried looking for an arbitrage opportunity with a warrant and an option? - they don't exist, because the warrant market makers make sure the cost of the time premium is far more than the time value ascribed to by the options market. 

The reality for me is if I want to trade warrants (and sometimes I do), I seldom hold them for very long and never use them in combination with an option writing strategy. However, my option trades are usually delta neutral in nature most of the time. And if I want leverage, my instrument of preference is a CFD - quick, inexpensive and absolute mark to market leverage, the way I like it! 

By the way, if you are getting screwed by ETrade on the margins, try Comsec (it's who I am with). They have allowed me to use warrants as collateral in the past and haven't been too bad on margins.

Cheers


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## wayneL (24 March 2007)

Be careful with time spreads such as these diagonal spreads. You need to model them as they *can lose if the underlying goes up TOO much.

They're not just a covered call with insurance.


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## BradK (24 March 2007)

Hi Wayne, 

Yes, I wanted to gear and write covered calls 

Four choices I guess: 

1. Buy the shares outright and write covered calls
2. Margin loan and write covered call 
3. Installment Warrants and write covered call 
4. Buy a deep in the money call and write a covered call. 

I chose number 4 on Oxiana last December. Hmmmmm... I bought $1.90 calls expiring in July for $1.30 (so, owes me $3.20). I find myself having to write $3 calls in January, February and March to make some money, and will try to exercise and sell off in the lead up to the divvy in April. Will break even if I get it a little over $3 but I havent made any money. I dont think it will recover too much. 

Has not been a positive experience, but theoretically it works. 

I am thinking of writing a longer term on something bluest of the blue chips such as QBE not so deeply in the money. 

Cheers
Brad


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## wayneL (25 March 2007)

BradK said:


> Hi Wayne,
> 
> Yes, I wanted to gear and write covered calls
> 
> ...




Hi Brad,

Covered calls are a funny strategy because a loss can be good or bad, depending on your philosophy.

Philosophy 1/ You put on the strategy to make a speculative profit.
Philosophy 2/ You already own the shares, don't intend to sell them and systematically write calls over them every month
Philosophy 3/ You already own the shares, don't intend to sell them and you write calls over them to extract some income while they are in a stagnant or downtrending phase

It's been well documented that I am very critical of  philosophy 1. Why? Because there are far better risk/reward speculative strategies. The problem is the negative gamma. In other words, profits decelerate and are capped, whilst losses accelerate and are undefinable. In choppy range markets, this negative gamma may cause a loss, even though the stock ends up at the same price after a period of time. This is counterintuitive, yet remains a real possibilty. It also causes people to look for high IV situations and therefore high risk (yet still capped profit)

I'm lukewarm on philosophy two for some of the same reasons as above, however, over the long term it is a profitable strategy good for steady, low to medium volatility stocks... providing it doesn't tank on you one day.

Philosophy three is where I am in favour of CCs. In your situation above; supposing OXR was in your portfolio, not to be sold. You have actually pulled in some call premium while OXR was in a choppy sideways/down corrective stage... even though you are down a bit on the stock (you were going to cop that capital depreciation anyway). Perfect.

As far as leveraging, and if you nevertheless like this type of strategy, I think the best way is a OTM bull put vertical. But I only put these on with a view to morphing into a condor later. (these are personal preferences and not advice... actually I prefer *ATM* verticals if I'm thinking moderately directional)

There are folks running around who have done very well with this strategy ( the bull put)... but any bullish strategy works in a relentless bull market. In a decent bear, you'd better be very nimble otherwise you get chopped to pieces.

These strategies are universally promoted by the seminar clowns as a low risk cash flow panacea. However this is not the case in reality, particularly in normal markets (and this is not a normal market)

Some things to think about  

cheers


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## wayneL (25 March 2007)

Oh forgot about diagonals.

These are fine if the stock doesn't move, or moves up a bit, but as the stock starts moving higher your profit starts getting trimmed. This is because of the delta and gamma of the long call.

If the Delta is somewhat less than 1, and gamma is low (which it will be with long expiries and particularly with high IVs) you will move into a loss if the stock moves up too much.

This can be corrected though by using a slight ratio. If you have 10 calls with a delta of .7 then sell 7 calls instead of 10. But it will cost you a bit in premium collected and raise you risk slightly.

These are all things you CAN do, but I am not advising you DO do.

Do your own research yada yada yada

Cheers


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## BradK (25 March 2007)

Thanks for that Wayne. 

My worst experience? I wrote a naked LHG $3 call when they were trading at $2.90ish during early February. They raced to $3.50 that month - but I bought it back at when the stock got to $3.07 for a minor loss - sat back - could have been much worse! 

The moral? Don't write naked calls! 

Cheers
Brad


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## bingk6 (25 March 2007)

reece55 said:
			
		

> Trust me, you will pay far less of a premium on the call option than you will on the warrant. My point here is that the warrant writers screw you with a much higher cost of the leverage than say an option or CFD will.




Hi Reece, many thanks for your reply.

If I am reading this correctly, are you saying that a call warrant with the same exercise, same expiry, and assuming a ratio of 1:1 will cost more than the equivalent call option ? If so, I cannot see how that is (or rather should be) the case, as both the option and warrant entitle the buyer to exactly the same deal, that is the right to purchase the stock at a certain price by a certain time. So theroitically, their pricing should be identical, subject off course to the necessary adjustments due to the fact that installment warrants pay dividends whereas call options do not. In any case, very interesting topic and thanks for alerting me so that I will examine it further. 


			
				reece55 said:
			
		

> By the way, if you are getting screwed by ETrade on the margins, try Comsec (it's who I am with). They have allowed me to use warrants as collateral in the past and haven't been too bad on margins.



I shall seek an audience with them at once.


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## bingk6 (25 March 2007)

BradK said:


> I chose number 4 on Oxiana last December. Hmmmmm... I bought $1.90 calls expiring in July for $1.30 (so, owes me $3.20). I find myself having to write $3 calls in January, February and March to make some money, and will try to exercise and sell off in the lead up to the divvy in April. Will break even if I get it a little over $3 but I havent made any money. I dont think it will recover too much.
> 
> Has not been a positive experience, but theoretically it works.




Hi Brad,

Is there any particular reason why you chose the long calls to have an expiration of 6-7 months ?? Also, at the time of iitiating the long call, did you perform any analysis on the IVs at the time ??

I have been trying to setup some spreadsheet analysis that attempts to locate quality optionable stocks on the ASX that I believe are undervalued (say 30 or 60 day low, and whose IV at the time are also low - say lowest 10% percentile over the last 120 days). At that time, I initiate a slightly OTM (1- 2 strikes) long call (12 months or more till expiry). 

After establishing the long call, I then proceed to sell *monthly* slightly OTM calls (1-2 strikes again). If the price rises and the short call moves ATM or even ITM, I will close the position. If I have to close the short call, I will lose money on it, but my long call will appreciate. OFcourse, if the short call finishes OTM, thats fine too and I will initiate another short call when the first one expires and on and on it goes.

In other words, at the time of initiating the short calls (which will always be slightly OTM at the timeof initiation), the strike price varies depending on what the current stock price is at the time - almost like a floating strike price.

This strategy works best when the stock price is stable or rising slowly, so that my short calls finish OTM and I don't have to close them, and my long term long calls benefit too. Ofcourse, if the IV increases after after initiating my long call, that would be a bonus.

Just my


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