Market Measures

Short Puts: Converting to Covered Calls

| Nov 8, 2016
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    Market Measures

    Short Puts: Converting to Covered Calls

    Nov 8, 2016

    We strongly believe that your best chance to be profitable when buying stock is to use tools that lower your cost basis. A Covered Call is one way to do this. Long stock is combined with a short Call, either at order entry or after the long stock position has been established. The premium collected can be subtracted from the cost basis of the stock to lower the price. An alternative method is by selling Puts. Should the stock move lower one could hold the short position into expiration and be assigned the stock at the strike price. The premium collected for selling the Put(s) would be reduced from the price resulting in a reduction in cost basis. What happens if one sold Puts and went through assignment? Should the trader combine the two methods and sell Calls against the new long stock position or simply exit the position?

    Our study was conducted in the SPY (S&P 500 ETF) using data from 2005 to the present. We chose the option expiration cycle closest to 45 days to expiration (DTE) and sold the 30 Delta Put which was managed at 50% of max profit (if possible) or held to expiration. If we were assigned the stock we then sold a 30 Delta Call with 45 DTE against the position to create a Covered Call. We then managed for original profit target or held to expiration and only went out 1 additional expiration cycle.

    A results table of the short Puts that were managed at 50% was displayed. The table included the success rate, average P/L and average days held. As expected, the short puts have an extremely high win rate of 92%, but what about the remaining 8% that ended up being assigned? Can taking the stock and selling the call improve the results? A table of just the losing trades that resulted in a long stock position and then was turned into a Covered Call by selling 30 Delta Calls was displayed. Selling a 30 Delta call against the long stock position turned 45% of the losing trades profitable.

    A final results table compared all trades managed at 50% with all trades managed at 50% plus taking assignment and selling Calls against the new long stock position . The table showed that by extending duration the win rate and the average P/L improved and the average days in the trade increased by only 18%. Rolling the short Call(s) forward would likely have improved results but we needed a set time for the study.

    For more information on related subjects see:

    Watch this segment of Market Measures with Tom Sosnoff and Tony Battista for the valuable takeaways and the results of our study on converting short Puts that are assigned into Covered Calls.

    This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.

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