Re: Why dont value investors write more covered calls?
 

its a delicate game... most valuations obviously involve a bull case a bear case and everything in between, even if they have a target IV its not a very static idea, but more of a directional view on where a company is headed.

implied vol was very low in a mkt trending upward so often value investors over the past 5 years probably didnt want to cap their upside. now that implied vols are at very high levels i'd guess that you are going to see more and more covered call writing as the risk-reward profile improves.

also--if your valuation changes, you can always roll your position to a different maturity or strike... obviously crossing bid offer is a pain but its a more nimble position than you think.

Re: Why dont value investors write more covered calls?
 

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implied vol was very low in a mkt trending upward so often value investors over the past 5 years probably didnt want to cap their upside. now that implied vols are at very high levels i'd guess that you are going to see more and more covered call writing as the risk-reward profile improves.


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are you suggesting that implied volatilities are currently/will soon be higher than actual volatilities? or that implied volatilities were lower than actual volatilities over the past 5 years? what is your reasoning for suggesting that the risk-reward profile is improving?

Re: Why dont value investors write more covered calls?
 

I think he meant implied/actual as the same, but both have been huge since the summer and look like they will stay that way for the near future. It does look like 2-3 month rolling covered calls is the way to go..now if only I could write them.

Also the problem dc pointed out, options dont trade on most of my companies, is the main problem.


This seems like the best idea: "So I think it only works if the stock is getting near your IV estimate and then you can write calls every month until the stock is called. Assume you bought KO at $40 thinking it was worth $65. Right now you could make 35-45 cents a month writing $65 calls. Or you could write $62.50 calls for about $1.25."

Re: Why dont value investors write more covered calls?
 

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I think he meant implied/actual as the same

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if that's the case, the risk/reward should be the same, no?

Re: Why dont value investors write more covered calls?
 

by that I think he meant there are now high returns available for people willing to take on high risk. if you remember back in may/june, even risky debt was selling at extremely low yields.

Re: Why dont value investors write more covered calls?
 

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implied vol was very low in a mkt trending upward so often value investors over the past 5 years probably didnt want to cap their upside. now that implied vols are at very high levels i'd guess that you are going to see more and more covered call writing as the risk-reward profile improves.


[/ QUOTE ]

are you suggesting that implied volatilities are currently/will soon be higher than actual volatilities? or that implied volatilities were lower than actual volatilities over the past 5 years? what is your reasoning for suggesting that the risk-reward profile is improving?

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with a few exceptions, implied vol generally trades above realized vol. in times of panic, implied vol almost always trades above historical vol.

Implied vols now are way higher now than they have been over the last 5 years. the option market prices a one std deviation move in the S&P over one trading day to be ~1.75% over the next year. Over the last 5 years this number has been right around 1% or less.

If you are doing a buy write, you are selling an option. If the implied vols are high, the option is more expensive.... So when you are selling something more expensive, your risk reward looks more attractive.... You are selling something that you can get more juice for now than you could before... Of course, times are different now and you run the risk of not participating in big upward movements in the market if you decide to buywrite. That being said, if the markets turn around and start to trend higher, implied vols will decrease so you can always buy back the option you are short and make money on just the fact that the vols went down.

Re: Why dont value investors write more covered calls?
 

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But if you buy KO at $60 thinking it's worth $90, you need to write calls at $90.

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No you don't, you should write them short term at $65 or $70 and gain all the time and volatility premium. Reasoning is that if you thought the stock would go to $90 quickly you wouldn't have bought the stock in the first place, just the calls.


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The problem is you don't want to be called out of a stock that you think is worth $90 for $65. You can always buy back in, but can lose if the stock gaps up to say, $75 on good news. Even if you don't lose when you get called out, you are increasing transaction costs, converting long term gains to short term gains and losing your ability to defer taxes, one of the most powerful advantages of buying and holding. Essentially when you defer taxes you are getting an interest free loan from the government to invest. Covered calls aren't a free lunch, you are effectively selling upside at it's intrinsic value while making your investment less tax efficient.

It is attractive to think you can make high annualized profits if you get called out quickly. But we are talking about value investors. If I buy KO at $60 thinking it's worth $90 now, that means a year from now I will likely think it's worth $105. Just buying and holding, keeping tax rates to a minimum and deferring taxes can produce very high rates of return in an investment like that. Sometimes covered calls may work great, but my guess is that most time's it's better to hold, otherwise it would mean that calls are typically over-priced.

Re: Why dont value investors write more covered calls?
 

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implied vol was very low in a mkt trending upward so often value investors over the past 5 years probably didnt want to cap their upside. now that implied vols are at very high levels i'd guess that you are going to see more and more covered call writing as the risk-reward profile improves.


[/ QUOTE ]

are you suggesting that implied volatilities are currently/will soon be higher than actual volatilities? or that implied volatilities were lower than actual volatilities over the past 5 years? what is your reasoning for suggesting that the risk-reward profile is improving?

[/ QUOTE ]

with a few exceptions, implied vol generally trades above realized vol. in times of panic, implied vol almost always trades above historical vol.

Implied vols now are way higher now than they have been over the last 5 years. the option market prices a one std deviation move in the S&P over one trading day to be ~1.75% over the next year. Over the last 5 years this number has been right around 1% or less.

If you are doing a buy write, you are selling an option. If the implied vols are high, the option is more expensive.... So when you are selling something more expensive, your risk reward looks more attractive.... You are selling something that you can get more juice for now than you could before... Of course, times are different now and you run the risk of not participating in big upward movements in the market if you decide to buywrite. That being said, if the markets turn around and start to trend higher, implied vols will decrease so you can always buy back the option you are short and make money on just the fact that the vols went down.

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Jason, you realize we are talking about value investors, right? And that value investors rarely care about volatility? Typically value investors like options in situations where they have a good estimate of the likelihood of a specific business event happening, and the resulting value created from that event, and that allows them to value options regardless of what volatility is.

And I think the reasons I covered in my response to Jimbo address why most value investors don't use covered calls.

Re: Why dont value investors write more covered calls?
 

Desert Cat's last two posts exemplifies my response above, people are greedy. That's why they don't do covered calls.

Re: Why dont value investors write more covered calls?
 

wow I totally forgot about the taxes. I guess it makes sense when you think a stock is approaching IV and you are ready to dump and move on, but yeah, the fact that your money grows tax free is huge.