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2015issue C0143-53

Yearly at-the-money covered calls on a dividend basket

This archive case sold one-year at-the-money calls against a high-yield equity basket, one contract for every 100 shares, while still allowing dividends from the long stock. Editorial reading: fix that overlay first, then decide whether a correlated hedge stays optional or is never attached.

  • Covered call writing here means owning the shares and accepting a time-limited obligation to deliver them at a fixed strike.
  • The case sold one-year at-the-money calls, one contract for every 100 shares, and still allowed dividends from the long stock.
  • Sold calls were framed as a cushion against a decline, with the trade-off that the overlay limits participation when the names rally strongly.
  • A market, sector, industry, or peer hedge can stay off until needed, because both legs can move against the position and spread prices can move adversely.
Entries in this reading3 entries
Current trackHedging strategy25 readingsCovered call writing32 readingsOption income strategy47 readings

What the overlay fixed first

A covered call is described as owning the shares while accepting a time-limited obligation to deliver them at a fixed strike. This case study used Covered call writing with one-year at-the-money calls. An at-the-money strike sits at or nearest the current price of the underlying. Those contracts were chosen because they were described as carrying the most time premium versus the stock price. Time premium is the portion of an option price that comes from remaining life rather than intrinsic value.

The illustrated overlay sold one at-the-money call for every 100 shares held and still allowed dividends from the long stock. Sold calls were framed as a cushion against a decline. The same overlay limits participation in years when the names rally strongly.

When a hedge stays optional

Hedging strategy for a long stock or basket can use a market, sector, or industry fund or a peer name. A sector fund was treated as broader cover. A peer or industry name was treated as more correlated cover.

Repeating mid-month and month-end payroll-related flows, and news that is expected to lift one name versus a broad hedge, were treated as reasons to stay long and add the hedge only if needed. A hedge can fail or compound losses if both legs move against the position, and spread prices can move adversely.

A buy-and-hold owner can sell a call against shares already held. That Option income strategy treated out-of-the-money and overpriced contracts, plus a view of remaining time decay, as filters for the overlay. An out-of-the-money call strike sits above the current underlying price.

Combining an option purchase with an option sale produces a spread that is a credit when cash is received and a debit when cash is paid. A credit spread leaves cash in the account when opened. A debit spread takes cash out of the account when opened.

Quarter-point strike listings in some metals can split volume across many contracts and leave each option thinly traded with a wide bid-ask that is hard to overcome.

Modeled premium path of the ACM December 35 call

A slightly out-of-the-money December 35 call on AECOM, modeled at a $33.75 spot, bleeds from $1.44 of premium in late September to well under 20 cents by mid-December. A covered-call seller who waits too long is giving away the income this overlay is meant to collect. Points were read from the Options Analytix decay pane; the printed scale tag is 1.4354 dollars.
A slightly out-of-the-money December 35 call on AECOM, modeled at a $33.75 spot, bleeds from $1.44 of premium in late September to well under 20 cents by mid-December. A covered-call seller who waits too long is giving away the income this overlay is meant to collect. Points were read from the Options Analytix decay pane; the printed scale tag is 1.4354 dollars.ACM 20-Dec-2014 35 Call · 30 Sep–14 Dec 2014 · 2014-09-30T00:00:00.000Z to 2014-12-14T00:00:00.000Z

The platform holds the underlying at 33.75 dollars and implied volatility at 31.09 percent, so the path is a model at fixed spot and vol, not a live mark-to-market. Expiration is 20 December 2014.

Educational research material, not investment advice. Historical source context does not establish present-day performance.
16 of 23 in the Hedging strategy track
201528-35 pp.Next on Hedging strategyPair hedge to hold a valid idea through noiseA hard stop bounds a long that has gone wrong, but it can also flatten a still-valid idea when timing is slightly off or noise arrives first.
All readings on this track · 23 readings
  1. 1982Basis-managed hedges and related market substitutes
  2. 1990Options as insurance unless the process is complete
  3. 1996A price-weighted technology index as a hedge and sector proxy
  4. 2002Single-stock futures as a month, margin, and hedge overlay
  5. 2004Listed volatility futures as a portfolio volatility hedge
  6. 2006Customized commodity hedges for bond and equity portfolios
  7. 2007Use of capital for overnight pairs and hedge layers
  8. 2007Opening auctions, limit envelopes, and overnight hedges
  9. 2008A two-gate intermarket test for equity bear hedges
  10. 2010Gold futures after a large setback: cluster risk and hedge timing
  11. 2011Partial commodity hedges, seasonal timing, and option income
  12. 2011Commodity-linked shares are a wrapper, a performance-bond, and a hedge-design problem
  13. 2012Hedging an open bull vertical
  14. 2012Construct a two-pair and three-pair hedge rule book
  15. 2014Equity and SPY stress pairs with a scaled index hedge
  16. 2015Yearly at-the-money covered calls on a dividend basket
  17. 2015Pair hedge to hold a valid idea through noise
  18. 2015Unused peer hedge after an ATR-qualified pair entry
  19. 2016Continuous index hedges fail the annual cost test
  20. 2016A VIX overlay as three stacked constraints
  21. 2018Late-cycle index overlay to keep equity dividends
  22. 2019Treat a bear-market hedge as a regime switch
  23. 2019Hedged pairs as game-theory payoffs
By fieldOptions and volatility202 readingsBy year2015101 readings
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