Covered Calls with CFD hedge

[CenturionDroid]

G'day all

I have a question about writing covered calls, while short-selling the stock as a hedge to your position

Basically, If you were to simultaneously:

a) Buy 1,000 BHP at $30
b) Sell 1,000 BHP at $30 using CFDs.
c) Write 1 covered call contract at say $32 strike with a 1 month expiry and collect a $2.38 premium

Wouldn't this hedge your physical stock you bought at $30, and allow you to collect the premium of $2,380 ?

You would have to set a stop-loss on the CFD hedge, at your break-even point (ignoring brokerage) of $34.38

I guess the only problem is if your CFD position gets stopped out and you don't get exercised....then the stock price could plummet under $30 and you make an unrealised capital loss on your shares as well as what you lost on the CFD's..........

Does anyone have a suggestion, using CFD's or other derivatives, for how you could:

a) Generate income selling options
b) Hedge any risk of a capital loss
c) Have a worst-case situation of breaking even (forgetting brokerage)

Thanks

Allan (newbie)

 

[sails]

G'day all

I have a question about writing covered calls, while short-selling the stock as a hedge to your position

Basically, If you were to simultaneously:

a) Buy 1,000 BHP at $30
b) Sell 1,000 BHP at $30 using CFDs.
c) Write 1 covered call contract at say $32 strike with a 1 month expiry and collect a $2.38 premium

Wouldn't this hedge your physical stock you bought at $30, and allow you to collect the premium of $2,380 ?

You would have to set a stop-loss on the CFD hedge, at your break-even point (ignoring brokerage) of $34.38

I guess the only problem is if your CFD position gets stopped out and you don't get exercised....then the stock price could plummet under $30 and you make an unrealised capital loss on your shares as well as what you lost on the CFD's..........

Does anyone have a suggestion, using CFD's or other derivatives, for how you could:

a) Generate income selling options
b) Hedge any risk of a capital loss
c) Have a worst-case situation of breaking even (forgetting brokerage)

Thanks

Allan (newbie)

Hi Allan,

By buying the stock and then selling CFDs simultaenously it technically (aka synthetically) closes the stock position so that you have the same risk as a naked sold call.

Admittedly, you can place a stop loss on the CFD if BHP goes up strongly, but that would be the same if you simply had the naked short call and decided to buy the shares at that same point.

Using your suggested strategy, if BHP went into a trading halt and then gapped up strongly, your short call would still cause similar losses to a naked short call at that same strike.

Sadly, there's no free lunch or easy way to collect premium by means of theta decay - there is usually always a risk lurking somewhere no matter how creative we become. Depends how much risk you are willing to take on for a little premium.

Some have done "collars" - this is where you buy stock and lower (otm) puts to offer some protection for the stock and then sell calls. It is a bullish to neutral strategy and generally can still lose more on the stock than can be replaced by the selling of calls - especially in the strong down conditions we have had recently. It is much the same as a bull call spread with a slight difference in the cost of carry (interest).

Cheers

 

[BradK]

The only ultimate protection I can see is to buy your stock - buy a put to protect its value... and then write calls against the stock.

The cost of the put might take 75% of potential annual premium if you write it at the money - or you can opt for a lower priced put.

All the best with it

Brad

PS. CFD's are the best route to an early grave. Stick with options buddy.

 

[wayneL]

Does anyone have a suggestion, using CFD's or other derivatives, for how you could:

a) Generate income selling options
b) Hedge any risk of a capital loss
c) Have a worst-case situation of breaking even (forgetting brokerage)

Thanks

Allan (newbie)

All the above points of sails and Brad, +

a) Generate income selling options

Of course, but with risk. (as per Sails)

b) Hedge any risk of a capital loss

Yes but at a cost (as per Brad)

c) Have a worst-case situation of breaking even (forgetting brokerage)

No. See http://sigmaoptions.blogspot.com/2008/05/quick-word-on-risk.html

My best advice is to get au fait with option synthetics. What you have there when it all boils down is a synthetic naked short call... but with a bunch of unnecessary commissions.

I do't think that's what you really wanted.... knowledge of synthetics would have shown you that.

 

[wayneL]

c) Have a worst-case situation of breaking even (forgetting brokerage)

Actually, being truly tricky and pedantic, there is a position where the worst case scenario is approximately break even:

Buy Stock
Sell Call
Buy Put of same strike and expiry as the Call.

Presuming the market has priced put-call parity properly (99.99999999999999999% of the time) you cannot lose.

The only problem is that you cannot gain either.

It's called a "conversion" and used by market makers to lock in arbitrage profits, but not much chop for us retail traders.

 

[BradK]

Wayne,

I am half way through your options course. It is very good.

My main bread and butter has been covered calls (although not in the past 18 months) - but I am currently looking to buy some long dated calls (12 months out) on some down and out blue chips (not banks!) and write against them - calendar bull spread.

What other strategies suit these times in your opinion?

Brad

 

[CenturionDroid]

All the above points of sails and Brad, +

a) Generate income selling options

Of course, but with risk. (as per Sails)

b) Hedge any risk of a capital loss

Yes but at a cost (as per Brad)

c) Have a worst-case situation of breaking even (forgetting brokerage)

No. See http://sigmaoptions.blogspot.com/2008/05/quick-word-on-risk.html

My best advice is to get au fait with option synthetics. What you have there when it all boils down is a synthetic naked short call... but with a bunch of unnecessary commissions.

I do't think that's what you really wanted.... knowledge of synthetics would have shown you that.

Thanks for the info - you've all given me alot to think about

 

[wayneL]

Wayne,

I am half way through your options course. It is very good.

My main bread and butter has been covered calls (although not in the past 18 months) - but I am currently looking to buy some long dated calls (12 months out) on some down and out blue chips (not banks!) and write against them - calendar bull spread.

What other strategies suit these times in your opinion?

Brad

Hi Brad, I've got a million miles to go on that yet, been reeeeelly slack.

Anyway, good strateges.... It depends whether you believe the implications of implied volatility, and what you read out of that.

If we use the premise that IV is somewhat predictive of realized volatility, then the Mr Market (actually, I reckon it's a female, what do you think? ) is expecting volatility to settle down over the nearer term... and it's getting more sure about that. That means it believes the bottom is in for the near future.

I've avoided iron condors on indexes for a few months now, but now "could" be a good time to give it go again because of the short vega. I'm still cautious though because the economy is not out of the woods yet, and don't want to be short lots of gamma in a really fast market.

Apart from the acquiring shares strategy detailed in another thread, I'm eeking out some bread money by writing WAAAAAAAAAAAAAAAAAAAAAAAAAAAAAY out of the money credit spreads both call and put, depending on the technicals, when the net premiums available reflect better odds than the risk. eg I wrote a $35-$30 Nov bull put lat month at > $50 credit a spread , TGT $22.5-$20 nov bull put at > $30 per spread Thems odds don't come up very often.

I've done a couple of long straddles/gamma trades but chicken feed there at the mo, hasn't really worked that well with the low gamma and declining vols.

In other words, like you, I've chickened out of taking directional bets, for the moment anyway. I'm betting on volatility and defending vigourously, if necessary.

 

[mazzatelli1000]

I've avoided iron condors on indexes for a few months now, but now "could" be a good time to give it go again because of the short vega. I'm still cautious though because the economy is not out of the woods yet, and don't want to be short lots of gamma in a really fast market.

In other words, like you, I've chickened out of taking directional bets, for the moment anyway. I'm betting on volatility and defending vigourously, if necessary.

Scary times for condors WayneL
But I have been crazy enough to plonk some on OIH.
Range is 35 - 110 --- haha please Ms Market let me survive

 

[wayneL]

Scary times for condors WayneL
But I have been crazy enough to plonk some on OIH.
Range is 35 - 110 --- haha please Ms Market let me survive

Noice!

At least the volatility gods will let you write ludicrously far away strikes. probably a safer trade than in "normal" times.

 

[shirls12]

What about using CFDs to cover your written call or put position. You can place a guaranteed stop (0.3% in IG markets) and write in the money to protect. The CFD only requires 5-10% margin effectively multiplying your returns. Have been looking around for any info on the topic but havnt had much success so if anyone knows anything that would be great.

Any info would be great as am excited about the potentials in this strategy

 

[tracernet]

I'm also a newbie, but have just discovered writing deep in the money covered calls on CFD's. I wrote my first ones in Dec and the Jan expiry is due at the end of the week. I am only learning (using a little cash), so my brokerage is bringing down my earning ratio, but looks like 8% or so net for this month. It's a once a month strategy, so very passive at this stage, but nice income strategy so far.

Only hole I can see is if the market drops a lot overnight hitting my stop loss (10% drop or more), then bouncing back higher than my strike in the same trading day (while I am sleeping). Thus turning me into a naked call owner. I've set SMS alerts if the stop is reached and my phone keeps pinging until the SMS is read so hopefully it'll wake me up in time to deal with this scenario before it's a real problem. Other than that situation, I can't see any other risks, but am worried that's because I am new and I don't know what I don't know.

 

[tracernet]

What about using CFDs to cover your written call or put position.

I did a course just recently on exactly that. I can let you know how it goes this month (about 1 more weeks time) if you want.

 

[bobmunger]

I've done the numbers and some paper trades on a strategy using CFD's to buy shares and writing covered calls on those shares.

Only really works if you write the call in-the-money (a guaranteed loss of capital) but where the premium is higher than the loss.

For example:

1. Buy shares of XYZ at $100.

2. Write a covered call at $90
(So you are guaranteed to lose $10 a share but the premium might give you $13 a share)

3. Buy a Guaranteed Stop-loss at your break even point ($90 in this case) and get your broker to close you out on your call if you go under the $90. Not all brokers do this, but I know there's at least one now with a few more to follow.

4. (in a nut shell) repeat each month for a guaranteed premium...

Obviously there's a lot more to it than just that so you'd have to do the maths and figure out if this is right for you. I've done some working out based on BHP against writing Non-CFD covered calls against CFD covered calls and its good way to get a leveraged premium.

 

[wayneL]

I've done the numbers and some paper trades on a strategy using CFD's to buy shares and writing covered calls on those shares.

Only really works if you write the call in-the-money (a guaranteed loss of capital) but where the premium is higher than the loss.

For example:

1. Buy shares of XYZ at $100.

2. Write a covered call at $90
(So you are guaranteed to lose $10 a share but the premium might give you $13 a share)

3. Buy a Guaranteed Stop-loss at your break even point ($90 in this case) and get your broker to close you out on your call if you go under the $90. Not all brokers do this, but I know there's at least one now with a few more to follow.

4. (in a nut shell) repeat each month for a guaranteed premium...

Obviously there's a lot more to it than just that so you'd have to do the maths and figure out if this is right for you. I've done some working out based on BHP against writing Non-CFD covered calls against CFD covered calls and its good way to get a leveraged premium.

3% extrinsic on a 10% ITM call?

I'd like to see that on a front month option.

 

[skyQuake]

I've done the numbers and some paper trades on a strategy using CFD's to buy shares and writing covered calls on those shares.

Only really works if you write the call in-the-money (a guaranteed loss of capital) but where the premium is higher than the loss.

For example:

1. Buy shares of XYZ at $100.

2. Write a covered call at $90
(So you are guaranteed to lose $10 a share but the premium might give you $13 a share)

3. Buy a Guaranteed Stop-loss at your break even point ($90 in this case) and get your broker to close you out on your call if you go under the $90. Not all brokers do this, but I know there's at least one now with a few more to follow.

4. (in a nut shell) repeat each month for a guaranteed premium...

Obviously there's a lot more to it than just that so you'd have to do the maths and figure out if this is right for you. I've done some working out based on BHP against writing Non-CFD covered calls against CFD covered calls and its good way to get a leveraged premium.

The prem you pay to the CFD provider reduces the viability. Have you also factored in funding costs? I always thought the CFD providers hedged Guarantee stop losses with oppies.

 

[wayneL]

I've done the numbers and some paper trades on a strategy using CFD's to buy shares and writing covered calls on those shares.

Only really works if you write the call in-the-money (a guaranteed loss of capital) but where the premium is higher than the loss.

For example:

1. Buy shares of XYZ at $100.

2. Write a covered call at $90
(So you are guaranteed to lose $10 a share but the premium might give you $13 a share)

3. Buy a Guaranteed Stop-loss at your break even point ($90 in this case) and get your broker to close you out on your call if you go under the $90. Not all brokers do this, but I know there's at least one now with a few more to follow.

4. (in a nut shell) repeat each month for a guaranteed premium...

Obviously there's a lot more to it than just that so you'd have to do the maths and figure out if this is right for you. I've done some working out based on BHP against writing Non-CFD covered calls against CFD covered calls and its good way to get a leveraged premium.

Lets look at some REAL numbers:

BHP(NYSE) closed at 94.43

The Apr 85 call closed at 9.75 bid 9.90 ask... let's say we get 9.80.

That means we get $0.37 extrinsic.

That's 0.4% return in six weeks on the value of the shares in 5-6 weeks with the real risk that BHP could trade below 85.

Take off brokerage and Guaranteed stop premium.

F### that!

 

[skc]

Lets look at some REAL numbers:

BHP(NYSE) closed at 94.43

The Apr 85 call closed at 9.75 bid 9.90 ask... let's say we get 9.80.

That means we get $0.37 extrinsic.

That's 0.4% return in six weeks on the value of the shares in 5-6 weeks with the real risk that BHP could trade below 85.

Take off brokerage and Guaranteed stop premium.

F### that!

Not to mention 0.13% or thereabouts interest per week to hold the CFD position...