Covered Calls – Top 3 Performance Insights from New Research

On this episode we go over the top three performance insights we learned from our massive study on covered call performance.
Covered Calls – Top 3 Performance Insights from New Research
Kirk Du Plessis
Mar 14, 2020

Today on the show we welcome a special guest, Rob, who’s the co-author of our recent research report on Covered Calls. If you trade covered calls right now or plan on using them at any point when dealing with assigned stock, then this show should be required listening.

What is a Covered Call?

  • A covered call is a combined options strategy that puts together long underlying stock and an options strategy where you sell a call option.
  • The reason it is “covered” is because the risk in the assignment of the call option is covered by the underlying shares.
  • You typically sell a call option at a strike price at or above where the stock is trading, looking to use the premium received from the call option to reduce your cost basis and, therefore, increase your probability of success.

Why Did We Research Covered Calls?

  • Our goal is to educate traders, and covered calls are often the gateway into trading options.
  • From time to time, we get assigned stock as part of the strategies that we trade. We wanted to know the best way to go about selling calls against those assigned positions.
  • We wanted to help first-time traders better execute covered calls.

What Did We Test?

  • We started with a large swath of data from OPRA (Options Price Reporting Authority), the industry-standard data.
  • We looked at 20 years of data from January 1999 to Mid-2019.
  • We tested 109 symbols (70 stocks and 39 ETFs) 
  • We tested 160 total different combinations of days to expiration, deltas, profit-taking, and stop losses per symbol.
  • This generated 5.6 million trades in our sample.
  • Example: Sell a covered call 30 days from expiration at a 30 Delta and let it go to expiration.

How Did We Analyze the Data?

We analyzed the data in several different forms and sorted the data into 3 different buckets:

  1. Performance of the underlying stock and ETFs
  2. How the options contract (short call) performed
  3. Covered call strategy as a whole

Covered call strategies are often described as “enhancements” to long stock. We wanted to know if the pairing of the underlying stock and a short call (the covered call strategy) actually enhanced the performance of just long stock. 

Top 3 Insights:

  1. Avoid selling covered calls on any single stock — ETFs saw significantly better performance.
  2. Stop losses are flawed logic — They led to more losing trades overall in our research.
  3. Reducing cost basis through call writing is not enough. 

Profit-Taking

  • Generally, in a lot of strategies we have tested, early profit-taking works well to increase returns and reduce drawdowns.
  • However, taking profits early is not necessarily the most profitable thing you can do.
  • There is a trade-off: if you take profits early, you increase your win rate and reduce the drawdowns and time in the trade; but, it is not necessarily the most profitable thing to do at the end of the day when you look at net returns. 
  • In covered calls, sometimes taking profits is not optimal. In many cases, early profit-taking led to 30-40% sub-optimal results compared to letting positions go longer toward expiration. Patience and not being overly aggressive taking profits early had a significant impact on the results.

Check out the full Covered Calls Performance Research Report. 

Option Trader Q&A w/ Moti

Trader Q&A is our favorite segment of the show because we get to hear from one of our community members and help answer their questions live on the air. Today’s question comes from Moti:

Hi Kirk. My name is Moti and I’m from Israel and I’ve been following your website and webcast for two years now. I wanted to say thank you for all the work and dedication to your members and community and to keep up the good work. I have two questions to ask. One, I noticed in your past trades and positions that you prefer to open new iron butterfly positions or tight iron condors when the IVR is not in its high range. Can you explain why? My second question is regarding position pricing. It’s almost always getting less than the minimum price in regards to the pop ratio, so how can I tell if it’s good pricing or not? Thank you again and bye now.

Remember, if you’d like to get your question answered here on the podcast or LIVE on Facebook & Periscope, head over to OptionAlpha.com/ASK and click the big red record button in the middle of the screen and leave me a private voicemail. There’s no software to download or install and it’s incredibly easy.

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