Writing covered calls over long CFD positions

[Adam2011]

Hi all,

I have heard that you can write deep in the money covered calls over long cfd's positions by setting a guaranteed stop loss at the break even point.

Example, Buy XYZ at $105, write deep in the money call at strike of $100 for $7.50 premium. Set guaranteed stop loss at $97.50. If stock stays above 100 you keep premium simple, if stock goes below your long position, it is closed out and then you buy your call back at a cheaper price than you bought it. (Very basic example of course) The strategy risk is then of course your brokerage costs and the differerence between the premium written cost and the the buy back cost. If you get stopped out then you simply look for another opportunity. Basically you have to hope that the stock stays above the strike price and you will make money on the premium.

Before everyone jumps in, yes I have heard that Daniel Kertcher is promoting this strategy and I have seen some other threads regarding this topic. Please lets not turn this thread into slammin him, other threads have already done this.

However, is it possible to actually do this strategy? I have scoured the net and no one has said you can't do it, although no one has confirmed they can. Some say its not worth it as brokerage eats up the premium, others are so busy being negative they haven't even bothered to look into it etc etc.

You can do the strategy through IG Markets however when i called them to ask about it, they said YES you can do the strategy and don't have to go through daniel kertcher, they said the position is cash settled and provided me with all this other info I didn't understand. I can't work out whether the 2 people i spoke to actually understood what i was asking.

Does anyone have any answers at all as the strategy does sound attractive especially if the stock is nicely trending upwards.

Also lets try to keep the thread positive and constructive if possible. Private maessage me if you like. Look forward to hearing replies...

Thanks

 

[cutz]

Sounds like an extremely silly strategy,

I’m not sure how CFD’s work with regards to cross margining but you certainly can’t lodge them as collateral with the OCH so there’s your first problem; you’re going to have to come up with cash margin.

What’s the point of writing a deep in the money call where extrinsic is SFA.

What’s the point of mucking around with 2 lots of bid/asks and brokerage where you can short a put for the same payoff.

 

[wayneL]

Sounds like an extremely silly strategy,

I’m not sure how CFD’s work with regards to cross margining but you certainly can’t lodge them as collateral with the OCH so there’s your first problem; you’re going to have to come up with cash margin.

What’s the point of writing a deep in the money call where extrinsic is SFA.

What’s the point of mucking around with 2 lots of bid/asks and brokerage where you can short a put for the same payoff.

Yep.

And what is the RoI of a DITM CC/NP after expenses? Half a percent at best?

Of course there are points in time when the basic strategy makes sense, but as an "all the time" system, it's like stealing leftovers from a pit bull; eventually the pit bull will bite your arm off.

Bank interest returns are as good and safer.

 

[village idiot]

Adam, if you wanted to take a slightly bullish view of a stock and trade that view by recieving a premium, which you keep as long as the stock stays above a certain level, (not an unreasonable strategy under the right circumstances), then the very worst way you could execute that strategy is by selling the ITM call and longing the cfd, all through IG markets. For a start the spreads they would offer on the ITM call would be horrendous, plus you get to pay a second lot of spread+commission on the cfd. These costs alone would wipe out any edge the trade may or may not have.

As has been stated here and numerous other places, selling the equivalent put (the 100 put in your example), offers the same payoff profile with far less costs. If you wanted to be stopped out of the trade at 97.50 then you can still just close it yourself at that point.

As far as whether you want to do it in the first place, well there is a known possible profit (the put premium), and there is some amount that can be lost if the trade goes south, which will not be as small as you think, and some probability of each possible outcome. Unless you know what you might lose under various circumstances, and the probabilty of each of those circumstances occuring, how can you have any idea of whether this trade might be profitable or not?

 

[Slouch]

I don’t get it. You buy it at $105 with SL at $97.50 so if stock moves below $97.50 before expiry you lose $7.50 on the stock. If the option price has moved back to say $4 (before expiry) then you have gained $3.50 from option but lost $7.50 on the stock, a net loss of $4 or $400 on 1 contract before expenses. There is no strategy where you are guaranteed to make a profit or b/e at the start. You can only lock in a profit if say the stock moves in the right direction before expiry eg you are able to adjust your stop loss etc.
Don’t confuse what happens during the trade with the position at expiry (as you have done).
Ciao

Hi all,

I have heard that you can write deep in the money covered calls over long cfd's positions by setting a guaranteed stop loss at the break even point.

Example, Buy XYZ at $105, write deep in the money call at strike of $100 for $7.50 premium. Set guaranteed stop loss at $97.50. If stock stays above 100 you keep premium simple, if stock goes below your long position, it is closed out and then you buy your call back at a cheaper price than you bought it. (Very basic example of course) The strategy risk is then of course your brokerage costs and the differerence between the premium written cost and the the buy back cost. If you get stopped out then you simply look for another opportunity. Basically you have to hope that the stock stays above the strike price and you will make money on the premium.

Before everyone jumps in, yes I have heard that Daniel Kertcher is promoting this strategy and I have seen some other threads regarding this topic. Please lets not turn this thread into slammin him, other threads have already done this.

However, is it possible to actually do this strategy? I have scoured the net and no one has said you can't do it, although no one has confirmed they can. Some say its not worth it as brokerage eats up the premium, others are so busy being negative they haven't even bothered to look into it etc etc.

You can do the strategy through IG Markets however when i called them to ask about it, they said YES you can do the strategy and don't have to go through daniel kertcher, they said the position is cash settled and provided me with all this other info I didn't understand. I can't work out whether the 2 people i spoke to actually understood what i was asking.

Does anyone have any answers at all as the strategy does sound attractive especially if the stock is nicely trending upwards.

Also lets try to keep the thread positive and constructive if possible. Private maessage me if you like. Look forward to hearing replies...

Thanks

 

[Adam2011]

Hi guys,

Thanks for the responses, it seems that the writing the put option is a better strategy by the looks. I just wonder how IG sell it to their customers then? As they did tell me you could do it through them.

Cheers Adam

 

[wayneL]

Hi guys,

Thanks for the responses, it seems that the writing the put option is a better strategy by the looks.

No.

It is the same strategy, just easier accomplished if there is no initial holding.

As to whether it is a good strategy... well that depends.

 

[wayneL]

Example, Buy XYZ at $105, write deep in the money call at strike of $100 for $7.50 premium. Set guaranteed stop loss at $97.50. If stock stays above 100 you keep premium simple, if stock goes below your long position, it is closed out and then you buy your call back at a cheaper price than you bought it. (Very basic example of course) The strategy risk is then of course your brokerage costs and the differerence between the premium written cost and the the buy back cost. If you get stopped out then you simply look for another opportunity. Basically you have to hope that the stock stays above the strike price and you will make money on the premium.

I actually just took the time to read your example. One strike in the money (i.e. the 100) is not a "deep" in the money strike IMO... not if you're getting $7.50 for it (indicating fairly lively volatility).

You would get stopped out many more times than you think you might.

And Slouch is bang on as well. Extrinsic will de-ball you pre-expiry unless very close to expiry.

 

[Robshan]

My understanding of the way it works is this ...

1. Long CFD XYZ at 107.5 for example
2. Sell ITM Call Option at Strike of 100.0 for a premium of $9.50 (example)
3. The loss of $7.50 is covered by the $9.50 premium with a $2 profit per CFD
4. Break even point for the trade is at 98.0 (not counting in the brokerage) which is where you set your "guaranteed" stop loss.

The key, from my understanding is to make sure that you're selling the call option for a premium that is higher than the loss incurred by the difference in CFD price.

Provided that you can find a broker A) who can do this and B) doesnt have massive commission costs for CFDs and Options, then it sounds like a fairly valid strategy.

 

[jaystar86]

Hi all,

One of my first posts here

I find this topic of interest for a few reasons... my calculations have shown that on average you only earn between 4-7% (not the 9% often talked about) using this strategy on USA shares. These same shares return between 2-4% using just a normal covered call strategy (Still in USA here). There are certainly exceptions to this.

However, my question to anyone planning to do this is. When you factor in the downside risk and the higher chances of being stopped out... is it worth it?

Regards,

Jayvan

 

[sails]

My understanding of the way it works is this ...

1. Long CFD XYZ at 107.5 for example
2. Sell ITM Call Option at Strike of 100.0 for a premium of $9.50 (example)
3. The loss of $7.50 is covered by the $9.50 premium with a $2 profit per CFD
4. Break even point for the trade is at 98.0 (not counting in the brokerage) which is where you set your "guaranteed" stop loss.

The key, from my understanding is to make sure that you're selling the call option for a premium that is higher than the loss incurred by the difference in CFD price.

Provided that you can find a broker A) who can do this and B) doesnt have massive commission costs for CFDs and Options, then it sounds like a fairly valid strategy.

And if XYZ makes a steady move up, the short ITM call will become DITM (D=deep) and could become at risk of assignment. Have you factored in the cost of selling the underlying shares and then buying them back to close the position? That means paying for double brokerage on the shares.

And, with the change to option contract size, there is a possibility of just one option being assigned. If there are minimum fees, the cost of frequent small assignments can quickly rob the trader of a fair bit of cash.

Unless things have changed, I don't believe the ASX allows CFDs as collateral for short options which most likely means having sufficient cash for increasing margins in the market moves against the short position.

And, in any case, why not just sell the OTM put at the same price/strike as the ITM call? There is often quite wide bid/ask spreads on ITMs so you could save on slippage. You would also save on slippage by not trading the CFDs at all. Don't forget that MMs make their money from those bid/ask spreads, so if you can transpose the whole complicated strategy into a simple OTM sold put which carries the same risk as your strategy, why would you want to give money away to the MMs?
Give it to charity instead...lol

Oh, and don't even think about selling ITM calls on an underlying that is about to go x-div. Most likely there wouldn't be enough extrinsic value to sell anyway, but ITM calls are very likely (almost guaranteed) to be assigned the day before x-div. Problem is that you don't know about it until x-div day when it's too late and you will have to pay the full dividend due to the short share position you hold due to assignment.

Suggest you do a lot more research and make sure you absolutely understand what you are getting yourself into. There are many traps for the unwary - mainly in the area of short option positions, but also long option positions that are not closed out before expiry.

 

[sails]

Hi all,

One of my first posts here

I find this topic of interest for a few reasons... my calculations have shown that on average you only earn between 4-7% (not the 9% often talked about) using this strategy on USA shares. These same shares return between 2-4% using just a normal covered call strategy (Still in USA here). There are certainly exceptions to this.

However, my question to anyone planning to do this is. When you factor in the downside risk and the higher chances of being stopped out... is it worth it?

Regards,

Jayvan

Welcome to ASF, Jayvan...

Yes, the position being discussed of long CFDs + ITM short call option has an almost pararell risk to simply shorting an OTM put (at the same strike & expiry) as the ITM call option. There will be a little less premium to sell, but that is mainly due to interest which is calculated differently between put and call options. If you analyze it, you will most likely find that the interest you pay on the CFDs and deduct that from the premium on the short call works out to be similar to just selling the put. In fact, selling the put may be better as I believe that options are priced with the risk free rate where CFDs usually have at least a couple of percent higher than the risk free rate.

So, when it comes to risk, would you be OK with a naked short put? If the answer is "no way", then this strategy being discussed is just as risky.

You may have been told that you can put a stop loss on the CFDs - you can also put a stop loss on your put option.

And, what if you trigger a stop loss on your CFD which then leaves your short call unprotected and then the market abruptly turns up? Then you have unlimited upside risk...

And if you decide to close out the option at the same time the CFD stop loss is triggered, you have done the same thing as simply closing a naked short put that is going against you except you have given away more slippage to the MMs than you would if simply closing the short put.

Why people want to make the simple things complicated is beyond me. Must have come from the same school as Gillard...lol

 

[Robshan]

Suggest you do a lot more research and make sure you absolutely understand what you are getting yourself into. There are many traps for the unwary - mainly in the area of short option positions, but also long option positions that are not closed out before expiry.

Naturally this requires more investigation ... it's not something to dive straight into.

My understanding (from what I have been told) is that as of Feb 2010 you can trade options on CFDs ... so from your response, you are calculating that I have CFD positions on shares and then have options directly on the shares rather than the CFDs?

I've been learning about covered calls on shares but yesterday was the first time that I've heard of covered calls on CFDs ... hence my current research

 

[sails]

Robshan, I guess the main point is that if you are going to write an ITM call + buy CFDs for upside protection, it would be well to consider simply writing an OTM short put at the same strike/expiry.

Far less complicated, less slippage and brokerage and extremely similar risk/reward to the short itm call + long cfds.

Whether you use shares or cfds for upside protection against the short call is somewhat irrelevant (if the ASX will now allow cfds as collateral for the short call). It's not entirely irrelevant though, as there may be a higher interest charge on cfds compared to writing calls over shares you own outright. Of course, if using margin lending to purchase shares, it is possible that interest rates would be comparable to those charged for cfds.

The other thing is that there is often very little slippage when buying shares, whereas, cfds usually only offer a bid/ask spread and to to buy, you usually have to take the higher "ask" price. With shares, you can often get a better price by going into the queue.

But then it's a long time since I have traded cfds, so suggest you do your own research as things may have changed. However, I cannot see the point of writing an ITM call + shares or cfds when you simply write the put.

Of course, if you are planning to write an OTM call option, then it's not so smart to write the counter part ITM put as there would be more immediate risk of assignment if the market goes down quickly. Otherwise, it really doesn't make any difference to the risk/reward profile of either position.

And, if you are considering writing options, make sure you understand exactly how your broker treats assignment including any additional charges they might have and how long you have during that next day to close out of it before they take action themselves. IB allow a tiny 10 minutes...

 

[skyQuake]

Also factor in interest charge on the long CFD position
and that Guarantee stop losses may incur an additional charge.

 

[Robshan]

Also factor in interest charge on the long CFD position
and that Guarantee stop losses may incur an additional charge.

Yeah, I'm aware of these factors....

Sails, are you making the assumption that I'm anticipating a bearish market so am trying to protect my upside?

My outlook on the market direction is irrelevant in this scenario although I dont want the market to drop too far .....

If I'm long a stock trading CFDs but then write an ITM call option against the position then I have generated cashflow from the premium of the call option. If I write the call option at a strike price where the premium per CFD is greater than the loss incurred by being exercised then I have a profit regardless of whether the market goes up, down or sideways. The only thing that I have to watch out for is a sharp drop in the underlying share price which pushes the CFD value below the exercise price which is where the guaranteed stop comes into play and I have that set my break even level (as per my original post).

My understanding of the brokerage/fees for the trade are:
1. Cost per CFD or broker's minimum cost both in and out.
2. Cost per contract for the call option
3. Cost for the guaranteed stop.

Would I be right to assume that if price does in fact drop to my stop level during the month that I have written the option for, then I will also have the cost of buying back the option as well so that it's not exercised against a position that is closed?

From what I can tell it's pretty similar in strategy to a Protected Buy Write or a Covered Call with a protective Put in the share market .... the advantages are the brokerage on CFDs compared to shares as well as the lower capital outlay seeing as though CFDs are a leveraged instrument.

 

[sails]

Sails, are you making the assumption that I'm anticipating a bearish market so am trying to protect my upside?

No, but the major risk is to the downside and one needs to be prepared and there should be a plan on how to handle it.

My outlook on the market direction is irrelevant in this scenario although I dont want the market to drop too far .....

Exactly - but what if it does drop too far? We have no control over the underlying.

My understanding of the brokerage/fees for the trade are:
1. Cost per CFD or broker's minimum cost both in and out.
2. Cost per contract for the call option
3. Cost for the guaranteed stop.

Would I be right to assume that if price does in fact drop to my stop level during the month that I have written the option for, then I will also have the cost of buying back the option as well so that it's not exercised against a position that is closed?

Yes you will the cost of buying back the option if it is ITM at expiry or be assigned (which will probably cost you more in brokerage). Also, you will have slippage (the amount between the bid/ask spreads).

From what I can tell it's pretty similar in strategy to a Protected Buy Write or a Covered Call with a protective Put in the share market .... the advantages are the brokerage on CFDs compared to shares as well as the lower capital outlay seeing as though CFDs are a leveraged instrument.

No, it is different. With a protective put, you don't get stopped out. If you are stopped out of the cfd position, you are out and you miss out should the underlying turn back up. A protective put gives you the luxury of remaining in the position and can take advantage of a turn back up to get out at a better price if you think it is just a retracement in a down market. If you think it's in an uptrend, you are still in the position. It's very likely the cfd MM will buy the put to protect the cfd provider but you pay for it as a "stop loss price". The MM laughs all the way to the bank...lol

So, again I ask - why bother with this complex strategy when you can sell a put at the same strike/expiry as your anticipated ITM call price. In fact, you can turn it into a put credit spread if you want the advantage of a protected position.

But there is risk in every option position. You seem determined to follow this cfd + itm call nonense, so this is my last post on this subject...

 

[Robshan]

But there is risk in every option position. You seem determined to follow this cfd + itm call nonense, so this is my last post on this subject...

Pfft ... nice cop out.

I'm not determined to do this strategy, I'm just trying to get my head around why this would or would not be advantageous ....

I've taken your feedback in each post on board as I only heard one side of the story when I learned about this strategy. Forgive me if I was mistaken into thinking that the purpose of the forums was to share insight, discuss and gain perspective.

 

[wayneL]

Pfft ... nice cop out.

I'm not determined to do this strategy, I'm just trying to get my head around why this would or would not be advantageous ....

I've taken your feedback in each post on board as I only heard one side of the story when I learned about this strategy. Forgive me if I was mistaken into thinking that the purpose of the forums was to share insight, discuss and gain perspective.

Eh?

Sails has shared much valuable information and insight and you kick sand in her face?

Sir, your bad manners are exceeded only by your bad manners.

 

[sails]

Pfft ... nice cop out.

I'm not determined to do this strategy, I'm just trying to get my head around why this would or would not be advantageous ....

I've taken your feedback in each post on board as I only heard one side of the story when I learned about this strategy. Forgive me if I was mistaken into thinking that the purpose of the forums was to share insight, discuss and gain perspective.

I thought I had given you quite enough information already and I do have other things going on beside sitting here typing. Information gleaned from years of experience in trading options as a retail trader and lots of knocks along the way.

The reason I'm not impressed with this strategy is that I got sucked into covered calls (protected with puts) after attending a seminar. We were going to be millionaires in a very short time by leveraging up to the hilt with margin lending...lol. Needless to say, things didn't go as planned and got burnt - not mortally, but enough to realise I was a small fish swimming with sharks. So I decided to learn as much about options as I could and have been happy to share any knowledge gained in an effort to spare other retail traders some pain.

I think I have summarised the pitfalls of the strategy in question pretty well and feel I have no more to add. I have also suggested you look at the synthetic version of this strategy which is constructed with puts and saves a considerable amount in slippage and brokerage.

If the risk of the put strategy isn't for you, then the risk of the cfd (or shares) + itm calls has the same risk (well almost give or take a bit on interest).

It's not out of spite to refuse to discuss it further, however, I feel I have generously shared the best of my knowledge already with you. There are others around here whom I consider more advanced in options knowledge than myself, and am content they would quickly correct if they feel I am wrong...lol

I am happy to discuss options trading in general, but personally feel this strategy has no merit UNLESS one already owns long term shares and wants to sell well OTM calls over those shares to increase the returns a little.

Cheers


PS - thanks Wayne - yes I was a bit surprised to get the nasty response after spending a fair bit of time today giving the information. It doesn't worry me as it may help someone else reading this thread...