TUTORIAL: BUYING POWER EFFICIENT CC OVERWRITING
Updated
Let's face it. Being in a net delta long covered call in a market downturn can blow. Typically, the vast majority of covered calls are 70-80 net deltas long per one lot, depending on how aggressive your are with your short calls. There are a number of solutions to cutting that net delta to something more tolerable: (a) sell calls; (b) sell short call verticals/diagonals; (c) buy long put verticals/diagonals; or (d) drive your short calls to at-the-money or into-the-money. This post discusses overwriting your covered calls with short call diagonals.
While selling calls against is the most straightforward of approaches, many brokers won't allow naked call selling, particularly in cash secured environments like IRAs. Moreover, selling naked against may not be the most buying power efficient of approaches. The short call diagonal not only provides a work-around to the "no naked call" prohibition, it may also afford some buying power relief over going naked.
Pictured here is a laddered, short call diagonal, overwrite setup (say that quick three times) in the September, December, and March expiries of SPY with the short options camped out at their respective 20 delta strikes, the longs at "cheap." It pays 6.31 in credit, has a theta of 5.49, and is -53.77 delta. It's naturally applicable to any underlying and can be modified to afford you the amount of overwrite/delta-cutting that you want, even where you're not in a one lot.*
You can naturally also just ladder out short call verticals with the short legs at the 20's and the longs at "cheap"; my preference, however, is for getting into the longs once so that I can work the calls as though they were naked if they have to be managed, as opposed to managing a spread. Moreover, I can leave the longs alone throughout the life of the setup and re-use them even if they're no bid as buying power effect cutters, thus saving a bit on fees, since I'm only in and out of a single contract, as opposed to two, as I would be with a spread.
As usual, there are pluses and minuses to the setup. The pluses: (1) it flattens net delta, thus smoothing out your P & L in a downturn; (2) it provides additional cost basis reduction on top of any dividends you might be receiving by being in shares and/or with the short calls you've already got covering your shares. The minuses: (1) It ties up buying power to the extent of the width between the short call and long call strikes minus any credit received; (2) the additional short calls have to be managed if tested.
* -- For example, the pictured setup would flatten the net delta of a 53 share SPY position to virtually flat, since 53 shares of SPY are 53 delta long and the setup is 53.77 short.
While selling calls against is the most straightforward of approaches, many brokers won't allow naked call selling, particularly in cash secured environments like IRAs. Moreover, selling naked against may not be the most buying power efficient of approaches. The short call diagonal not only provides a work-around to the "no naked call" prohibition, it may also afford some buying power relief over going naked.
Pictured here is a laddered, short call diagonal, overwrite setup (say that quick three times) in the September, December, and March expiries of SPY with the short options camped out at their respective 20 delta strikes, the longs at "cheap." It pays 6.31 in credit, has a theta of 5.49, and is -53.77 delta. It's naturally applicable to any underlying and can be modified to afford you the amount of overwrite/delta-cutting that you want, even where you're not in a one lot.*
You can naturally also just ladder out short call verticals with the short legs at the 20's and the longs at "cheap"; my preference, however, is for getting into the longs once so that I can work the calls as though they were naked if they have to be managed, as opposed to managing a spread. Moreover, I can leave the longs alone throughout the life of the setup and re-use them even if they're no bid as buying power effect cutters, thus saving a bit on fees, since I'm only in and out of a single contract, as opposed to two, as I would be with a spread.
As usual, there are pluses and minuses to the setup. The pluses: (1) it flattens net delta, thus smoothing out your P & L in a downturn; (2) it provides additional cost basis reduction on top of any dividends you might be receiving by being in shares and/or with the short calls you've already got covering your shares. The minuses: (1) It ties up buying power to the extent of the width between the short call and long call strikes minus any credit received; (2) the additional short calls have to be managed if tested.
* -- For example, the pictured setup would flatten the net delta of a 53 share SPY position to virtually flat, since 53 shares of SPY are 53 delta long and the setup is 53.77 short.
Note
I would note that the hedge is not cheap to put on: the basic math for the depicted setup: (370-307) + (370 - 314) + (370-320) - 6.81 = 162.19 BPE (total width of the spreads minus credit received). Compare a 90/30 Poor Man's Covered Put (PMCP) with the front month set up at the 30 delta strike, the back at the 90: SPY Aug/Mar 282/325, 31.83 db, BE at 293.17 versus 290.78 spot, 74% debit paid/spread width ratio, max profit of 11.17/5.58 at 50% max, delta/theta -60.72/5.02. I prefer keeping things on the credit side of the ledger, but the PMCP is awfully BP efficient in comparison.Trade active
Out of the Sept 307 "rung" for an .08/contract debit. Will look to re-up on strength to re-use the cheap longs calls I have out in March of '20.Trade active
Selling the 20 delta March '20 322's for 2.67/contract on strength to reuse unused units in the cheap ass long calls I bought to bring in BP.Trade active
Running into my Dec 314 short call on this up move. Naturally, it isn't ideal, since it means I have to watch extrinsic in the option, particularly around ex-divvy and then get ready to roll it out of harm's way if I don't want my shares to be called away here (I don't). It's currently got 3.50 of extrinsic left in it, so I should be okay for now, since the last quarterly was 1.38. If extrinsic decreases to less than that, and it's still ITM, I'll roll it up and out.Trade active
With 9 DTE, rolling from the Dec 314's to the Jan 315's for a 1.50/contract credit to avoid ex-divvy assignment risk, so now I've got the Jan 315's, March 320's, and March 322's, along with the longs at 370.Trade active
Rolling the Jan 315's to the February 318's for a .65 credit with this down move and minor vol pop.Trade active
Rolling the February 318's to the March 319's for a .65 credit, so I've now got the 319's, 320's, 322's in March, all of which are in-the-money. I can either allow some of my shares to be called away or re-up with the cheap longs farther out in time (they're no bid here) and keep working the overwrite. I'll probably do the latter, but will see how it goes ... .
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