Happy Memorial Day!
music selection: “Runaway” — Ladytron
weigh-in: 215.2 +1.0 – too much BBQ!
I recently covered my love for closed end funds (trading at a discount to NAV!) that are focused on the debt space. Another major part of my strategy is selling options for income. A lot of people come to options and first try to BUY options. They see an opportunity for doubling or tripling their investment and grow blind to the very real possibility of losing their entire investment. I’ve learned the odds are more in your favor when SELLING options.
All option pricing includes what is known as “time value”. This time value is a wasting asset. It declines to zero as expiry approaches. If you purchased the option, you must overcoming this wasting effect to make money. Even if you are right about the direction of the stock, you might lose money if the move isn’t large enough or soon enough. When selling time value, you are guaranteed to collect the full value as an upfront cash payment by holding to expiry.
Selling options also is a great way to lower risk. If you buy a stock outright and it declines 5%, you have an unrealized loss of 5%. If you instead sell a put, your loss is reduced by the upfront premium received as well as any amount the put was written out of the money. This risk reduction is a powerful but often overlooked part of selling options.
Yields get fat when the market is in distress. This can be a great source of comfort. When the market is taking a 50% beating, you have lost a little less and are recovering ground by the way of new positions that pay more than average as the premium written includes a volatility bonus.
Finally, the returns are repeatable and often exceed the long term average of being a buy and hold index investor. The long term return of the S&P with dividends reinvested is between 7-9%. Even in the current abysmal interest rate environment, I find it easy to get 12% annualized on a written put or covered call. I often get much more. If all you do is break even against the index, you still have win because you did it with less risk that holding the underlying equity.
Unless I roll UVXY puts, it is unlikely I will have any trades this week. Blackstone (BX) looks to expire out of the money over the weekend. I’ll be looking to roll it on Monday.
Devour your prey raptors!