Beating The Benchmark by Roberto Chahin
Use out-of-the money covered calls to improve your buy &
hold portfolio’s risk efficiency.
Unlike investors, most traders look at buy & hold
strategies as a necessary evil at best. Traders may
have a large portion of their portfolio in a basket
of stocks or exchange traded funds (ETFs) that they allow to roll with the market, hoping to at least get the
same returns as the benchmark of their preference, be it the
Standard & Poor’s 500 or the NASDAQ 100. The remainder of
their portfolio would be in their trading capital. Some simple
methods can improve the risk-adjusted return of this side of a
portfolio by using out-of-the-money covered calls. This can
also be complemented with your favorite technical analysis tools to further improve risk-adjusted returns and reengage
yourself in the active management of a buy & hold portfolio.
OUT-OF-THE-MONEY COVERED CALLS
An out-of-the-money covered call is simply established by
selling a call option on the stock or ETF in the investment
portfolio with a strike price higher than the current price of
the underlying. For example, if you hold SPY, the ETF that
tracks the S&P 500, and it is trading around 150.00, you could
initiate an out-of-the-money covered call position by selling
the 30-day 155.00 call. This position allows the SPY 30 days
to go up 5 points, or 3.3%.
If the SPY does not close above 155.00 on option expiration
day, you get to keep the premium collected at the sale of the
call option. This would act as a buffer if the stock drops in
price or would provide extra profit if it were to hold steady or rise less than the 5 points. If, however, the SPY closed above
155.00 on expiration, you would have to surrender the shares
at 155.00 and repurchase the equity position at market price.
The difference between the market price and the 155.00 strike
price would be your loss.