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Monday, September 7, 2015

Elevated Volatility -- A Good Time to Sell Options?

This chart shows the volatility index for the past year.  With the swift approximately 10% stock market correction during the past month, VIX has essentially doubled from less than 15 during most of this year to its current reading of 27.8.  With this elevated volatility, this post asks the question: "Is it a good time to sell Options?"  The Covered Calls Advisor's answer is an unequivocal "Yes"!

In the case of both of our preferred methods of investing -- that is Covered Calls (or their equivalent 100% Cash-Secured Puts), we establish our positions by selling options (not buying options).  When we do this, we immediately receive the proceeds from the options we sold.  Higher volatility corresponds to higher options premiums (for both Calls and Puts), so our potential annualized return-on-investment results increase along with an increase in volatility.  

The Covered Calls Advisor only establishes positions when the implied volatility (IV) of their options exceeds 20%.  This strategy enables the possibility of achieving attractive returns (>20% annualized on positions of approximately one-month duration) on relatively conservative positions (slightly in-the-money covered calls).  Normally (whenever VIX is below 20), this requirement (i.e. >20% IV) precludes the Covered Calls Advisor from establishing positions in broad market indices such as SPY, IWM, or QQQQ. 

To demonstrate how the current elevated volatility allows us to establish attractive positions even with broad-based market indices, let's consider a covered calls position on SPY (S&P 500 Index) using its prices as of the market close this past Friday (Sept 4th).  Below is the options chain for the SPY quarterly options that expire on Sept 30th.  Note: the closing price of SPY was 192.59. 


September 2015 (Expiration: 09/30) 

Strike Bid Ask Bid/Ask Midpoint Friday's Volume  Open Interest Implied Volatility
SPY1530I191-E   5.45 5.6      5.53 123    2445    23.20
SPY1530I192-E   4.82 4.96 4.89 15 1982   22.63
SPY1530I193-E   4.22 4.36 4.29 2479 5345   22.05
SPY1530I194-E   3.66 3.78 3.72 13 2380   21.44


September 2015 (Expiration: 09/30) 

Strike Bid Ask Bid/Ask Midpoint  Friday'sOpen Volume Interest Implied Volatility
SPY1530U191-E   4.45 4.59 4.52 61 19453   24.29
SPY1530U192-E   4.84 4.98 4.91 40 14551   23.76
SPY1530U193-E   5.25 5.39 5.32 2498 7891   23.23
SPY1530U194-E   5.69 5.84 5.765 0 5388   22.68

Details of this in-the-money (using the $191 strike price) covered calls position for SPY is as follows:
09/04/2015 Bought 100 SPY shares @ $192.59
09/04/2015 Sold 1 SPY Sep30,2015 $191.00 Call option @ $5.53
09/18/2015 Ex-dividend of $1.03343 per share

Two possible overall performance results (including commissions) for this SPY covered calls position are as follows:
Stock Purchase Cost: $19,267.95
= ($192.59*100+$8.95 commission)

Net Profit:
(a) Options Income: +$544.05
= ($5.53*100 shares) - $8.95 commissions
(b) Dividend Income (If option exercised early on day prior to Sept 18th ex-div date): +$0.00; or
(b) Dividend Income (If SPY assigned at Sept30,2015 expiration): +$103.34
= ($1.03343 dividend per share x 100 shares)
(c) Capital Appreciation (If SPY assigned early on Sept 17th): -$167.95
= +($191.00-$192.59)*100 - $8.95 commissions; or
(c) Capital Appreciation (If SPY assigned at $191.00 at Sept30,2015 expiration): -$167.95
= +($191.00-$192.59)*100 - $8.95 commissions

Total Net Profit (If option exercised on day prior to Sept 18th ex-div date): +$376.10
= (+$544.05 options income +$0.00 dividend income -$167.95 capital appreciation); or
Total Net Profit (If stock assigned at $191.00 strike price at Sep30,2015 expiration): +$479.53
= (+$544.05 options income +$103.43 dividend income -$167.95 capital appreciation)

1. Absolute Return (If option exercised on day prior to ex-div date): +2.0%
= +$376.10/$19,267.95
Annualized Return (If option exercised early): +54.8%
= (+$376.10/$19,267.95)*(365/13 days); or

2. Absolute Return (If stock assigned at $191.00 at Sep30,2015 expiration): +2.5%
= +$479.53/$19,267.95
Annualized Return: +33.6%
= (+$479.53/$19,267.95)*(365/27 days)

Either outcome provides a good return on investment.  These returns will be achieved as long as the stock is above the $191.00 strike price upon the Sept 30, 2015 options expiration.

Final Note: In considering whether to establish a Covered Calls position or a 100% Cash-Secured Puts position, consider their implied volatilities.  In this case with SPY, the table above shows the IV at the $191 strike price for the Calls is 23.20 and the comparable IV for the Puts is 24.29.  So, the slightly higher IV for the Puts provides a slightly better return-on-investment potential than for the covered call position detailed above.  So, the Covered Calls Advisor would normally choose to sell the Sept30,2015 $191.00 100% Cash-Secured Put option in this case rather than establishing its comparable Covered Call position.  However, in this particular instance since their is an upcoming ex-dividend date prior to the options expiration date, the covered call was chosen since a higher annualized return will be achieved (particularly if the Call option owner exercises their option on the day prior to ex-div in order to capture the quarterly dividend distribution).