The Volatiliy Index (VIX) is now at very high levels and reflects the current fear that pervades investors as a direct result of the coronavirus and the 30%+ sell-off that has occurred in the past month -- the swiftest 30%+ correction in history. Times like this offer a great opportunity for Covered Calls and Cash-Secured Puts investors like ourselves who sell Options. David Kostin, Chief U.S. Equity Strategist at Goldman Sachs issued a recent note to clients that included these comments: "For those who are comfortable with trading options, this moment in time might well be remembered as a golden age in the options market. In short, when bad things happen to stock investors, good things can happen to options investors."; and also "Yet if you can handle intense uncertainty, and you have the financial resources to weather this storm, selectively harvesting the options market's fear premiums might just help you to successfully navigate one of the nastiest episodes we have ever encountered in our personal and professional lives."
The new positions in the Covered Calls Advisor Portfolio, detailed below, were established in the iShares MSCI Emerging Markets ETF (EEM) and in the SPDR S&P 500 ETF (SPY), both with April 17th, 2020 options expiration dates. For the iShares MSCI Emerging Markets ETF position, five 100% Cash-Secured Puts were sold at the $32.00 strike at $1.16 per share. The Covered Calls Advisor is increasing Emerging Markets exposure (beyond that of the current Alibaba position). China, Taiwan, and South Korean companies comprise 59% of EEM and since these countries are much further along in recovering from the coronavirus pandemic and also remain undervalued by most fundamental valuation metrics relative to the U.S., their stock markets are likely to outperform over the next year.
For the SPDR S&P 500 ETF, one Covered Call was established by purchasing 100 shares at $238.29 and selling one Call at the $220.00 strike price for a premium received of $25.52 per share. Average options Implied Volatility (during more normal times) for both EEM and SPY is in the 15 to 20 range, but the current Implied Volatility for both of these positions was in the mid 50s, a very attractive premium received for selling these options. Given the current market volatility and the Covered Calls Advisor's Slightly Bearish outlook, conservative positions with strike prices moderately below the current ETF prices were established for both positions.
The recent aggressive actions by the Federal Reserve and the coronavirus legislation Congress is close to completing are very much welcomed to maintain markets liquidity and to address adverse economic impacts from the coronavirus pandemic. The stock market has responded to these actions with a strong two-day relief rally. But lousy economic news is undoubtedly forthcoming and it begins tomorrow morning with Unemployment Claims. Further alarming economic news inevitably awaits in the days, weeks, and months ahead and it remains to be seen to what extent this is already priced into the stock market at its current levels.
The Covered Calls Advisor is now about 35% invested (the remaining cash is in a money market fund). As is the case with both investments today, information will continue to be monitored closely and additional cash will likely be deployed in the days and weeks ahead. Daily tracking of U.S. new coronavirus cases (see link and the chart displayed below). Although the number of new cases daily in the U.S. continues to grow substantially, the prior exponential growth is beginning to show signs of plateauing albeit with a large number of new cases each day.
As detailed below, the potential return-on-investment results are:
- iShares MSCI Emerging Markets ETF : +3.6% absolute return in 24 days (equivalent to a +55.1% annualized return-on-investment); and
- SPDR S&P 500 ETF : +3.4% absolute return in 25 days (equivalent to a +49.6% annualized return-on-investment)
1. iShares MSCI Emerging Markets ETF (EEM) -- New 100% Cash-Secured Puts Position
The transaction was as follows:
03/25/2020 Sold 5 April 17, 2020 $32.00 100% Cash-Secured Put options @ $1.16 per share
Notes: The Open Interest in these Puts was 118,244 contracts and the Implied Volatility was 56.4. iShares MSCI Emerging Markets ETF was trading at $33.84 today when these Puts were sold.
A possible overall performance result (including commissions) would be as follows:
100% Cash-Secured Cost Basis: $16,003.35
= $32.00 per share * 500 shares + $3.35 commissions
Net Profit Components:
(a) Options Income: +$580.00
= ($1.16 per share * 500 shares)
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If EEM is above $32.00 strike price at Apr 17th expiration): +$0.00
= ($32.00 -$32.00) * 500 shares
Potential Total Net Profit (If EEM price is above $32.00 strike price at April 17th options expiration): +$580.00
= (+$580.00 options income +$0.00 dividend income + $0.00 capital appreciation)
Absolute Return: +3.6%
= +$580.00/$16,003.35
Equivalent Annualized Return: +55.1%
= (+$580.00/$16,003.35)*(365/24 days)
2. SPDR S&P 500 ETF (SPY) -- New Covered Call Position
03/24/2020 Bought 100 shares of SPDR S&P 500 ETF @ $238.29 per share
03/24/2020 Sold 1 SPY April 17, 2020 $220.00 Call option @ $25.52 per share
Note 1: the Implied Volatility of the Call option was 58.7 and its Open Interest was 4,739 contracts
Note 2: this was a simultaneous Buy/Write transaction
A possible overall performance result (including commissions) would be as follows:
Covered Calls Cost Basis: $21,277.67
= ($238.29 - $25.52) * 100 shares + $.67 commission
Net Profit Components:
(a) Options Income: +$2,552.00
= ($25.52 * 100 shares)
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If SPY is above $220.00 strike price at the April 17th expiration): -$1,829.00
= ($220.00 - $238.29) * 100 shares
Total Net Profit: +$723.00
= (+$2,552.00 options income +$0.00 dividend income -$1,829.00 capital appreciation)
Absolute Return: +3.4%
= +$723.00/$21,277.67
Equivalent Annualized Return: +49.6%
= (+$723.00/$21,277.67)*(365/25 days)
