Covered Calls

I was talking to a coworker this past week who owns a lot of individual stocks for the long term. I explained to him how he could sell covered calls (CCs) on them, which would be an essentially risk-free* way to generate income from assets he already owned and was planning to hold regardless.

(*With covered calls there are two supposed “risks”: 1) the stock price moves down; but that would happen anyway even if you didn’t sell calls against the shares. 2) the stock moves up sharply, but your profit is capped by the call you sold, so you don’t participate in all the upside; hardly a “risk” in my opinion, because you made good money on the trade.)

My friend said he has a lot of TSLA, so I decided to see what CCs on that might look like. I know it’s a very liquid stock with liquid options, and it’s pretty volatile so premiums should be fairly juicy. I also know that selling 4 weekly CCs will net you more premium than selling 1 monthly, so I approached it from selling 5DTE call options.

Before looking at TSLA’s price action I figured that selling CCs 10% higher than the current price of TSLA (the spot) might be a good balance between return-on-investment and risk of having the stock called away. (You get more premium the closer you go to spot, but that also increases the probability of losing your shares.) It’s Saturday, July 24, 2021, and TSLA closed Friday at $643.38. 10% higher than that (1.10 x 643.38) is 707.72. That’s perfect because there’s a 30Jul (5DTE) strike at 707.50. Here’s a shot of the TD Ameritrade Thinkorswim platform showing that strike:

The symbol TSLA is in the upper-left corner, the “Last” price was 643.38, we’re on the Calls side of the option chain, the Strike in the lower-right corner is 707.5, and the “Bid” price for that option is $3.90. So come Monday we ought to be able to sell a 30Jul 707.5 Call at the Bid price of 3.90. The Midpoint of the Bid and Ask is 4.10, and we might get that from TDA, or we’d almost certainly get 4.00, but I’ll use 3.90 because that’s guaranteed as long as market conditions don’t change too much before 9:30AM Monday.

So we’d pocket $390 for each of these CCs we sold (minus commission of 0.65, so call it 389). That doesn’t sound like a lot though, does it? Especially since 100 of our TSLA shares will be held as collateral while the contract is in effect. And that’s 100 x 643 = $64,300. And what’s $390 against $64k? Well, it’s exactly 0.60%. Nothing to get excited about, right? But remember, that’s over only one week. If you did that 4 weeks in a row you’d have made 2.4% in about a month, which is starting to sound like something. And if you did it for 52 weeks you’d have made 31% in a year, which is excellent by most anyone’s standards. Granted, you’d have to get a similar Premium-to-Spot ratio each week, but I’m assuming you’ll be able to for a while yet with TSLA. I’ve read of people claiming to make 20, 25, even 30% per year selling CCs, so I take this is “proof” of that.

But I hear you saying, “Hey Mike@10DT, what about the times TSLA goes up more than 10% in a week and my stock gets called away??” Me: “10% in a week? How often does THAT happen!?” Looks at charts: “Hold up a minute…”

Okay, so TSLA HAS gone up more than 10% in a week before. But not in the last month. And only twice in the last 6 months. And a couple more times in the 6 months prior to that. But depending when you placed the trades, you might not have gotten exercised: because maybe after you put the trade on the stock went down for 2 days before going up for 3 days, something like that, so it didn’t hit your +10% strike.

But if that’s more call-away risk than you want, maybe you sell CCs farther away from spot. Just realize that you won’t get the premiums, and therefore the returns, we saw before. See the Delta column in the screenshot above? Our +10% of spot strike was at 15-delta (15∆). Being that I call this website 10DeltaTrading because I like to sell Short Strangles there, I wonder if selling CCs at 10∆ might make sense? The 10∆ strike is 725, with a Bid of 2.40. Take out a 0.65 commission and the RoR is (239÷64,338)x52 = 19%. Not bad, but not as good as 31%. But your chance of having your shares called away goes down from 12.8% to 8.2% (the “Prob.ITM” column in the screenshot above). Or in other words, down from a 1-in-8 chance to a 1-in-12 chance of being called away.

So at 10∆, you should expect to lose your shares about once every 12 times you sell 5DTE CCs, or about once every 3 months if you do them weekly. For me I’d say that was just part of the game and either buy back the TSLA shares that were called away, or maybe buy another stock I was interested in. But there’s a way to get paid to buy TSLA back at a discount, and that’s Cash Secured Puts, which I cover in that post.