I’m on a mission to prove that leveraged ETF’s might be the only ETF you need to own. In particular, the Dow 30 leveraged ETF is one that I’ve decided to try to exclusively trade in my mini-account. I picked up 200 shares of DDM at $77 and sold the May $78 strikes for $1.90. This will be 2.5% return in less than 25 days and if DDM pops over $78 that will bring my return up to 3.7% and as always if DDM is down, I’ll move on to June, July or later calls.
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What if DDM drops, say, 5%? Then you’re stuck either writing calls that will result in a net loss or not writing calls, and hoping for a recovery…
If DDM drops 5%, you can ride it out or write calls further out into the future: July, November, or even January 2010.
I’ll ask a rhetorical question: what happens if your mutual fund drops? What about an individual stock?
There is a real-time example now. I bought XHB at $23 and sold calls for April which expired and now sold calls for May.
XHB closed at $22 which is a 4% drop. I actually have to wait till after May expiry but you can already take a peak at the September $23 strikes which are trading at $2.35. The January 2010 $23 strikes are trading at $3.40. If I sell the January $23 strikes for $3.40 then I’ll score a 15% return from May thru January + the returns I’ve already made.
In principle I agree, but bear in mind that call premiums are directly correlated to volatility.
That means that on a volatile ETF (like XHB), you are capping your (otherwise potentially large) upside without protecting your downside.
Unfortunately there’s no free lunch.
You are capping your upside and that’s part of the point but you are also protecting your downside by dollar cost averaging down.
If I bought XHB at $23 and sold calls for $1.50 then I’m really getting XHB at $21.50 right?
If I sell more calls for the next month for another $1.50, I now own XHB at $20 right?
If XHB pops to say $30 then you’ve locked in the gain of $1.50 and will revert to cash.
The key issue however is YOU DON’T KNOW what XHB will do tomorrow or next week. Will it be at $30 or will it be at $20?
Would you sell XHB at $25? or $26? or $28 or $30? At what point to you sell and how do you know for sure that it will go higher from $28 to $30?
This whole trading strategy is built on the premise that I’m going to bank 2% to 4% EVERY MONTH. Annualized that’s a 24% to 48% return and that beats any index fund.
There is no free lunch, only a heavily discounted one!
As always, I think you do a good job of explaining this stuff in simple terms. I will add my same comment from the last time that a similar subject came up -
You should only be buying ETFs that you would want to own - regardless of the short-term fluctuation in price. Whether it is DDM or XHB or whatever - if the price drops, you should be willing to ride out whatever happens, because you did some research and want to own the fund.
Agreed. I’m willing to own DDM and XHB over the long haul. XHB has been heavily battered over the past two years. Housing will eventually recover and I’m willing to own XHB for 10 years or longer.
The same with DDM. It’s a leveraged Dow 30 and I’m willing to own that same ETF for the next 10 years or longer.
I love this strategy because there’s no emotion. Once you start “regretting” that you didn’t stay in or are “hoping” that it will go up or are “fearful” it will drop you’ve committed yourself emotionally to these ETFs.
This is what I mean about “emotionless” trading. I earn 3% every month or so, if I get called I look for opportunities if I don’t get called, I sell next months options. If it goes down heavily, I ride it out - See OIH or EEB in my mini/power accounts.
“This whole trading strategy is built on the premise that I’m going to bank 2% to 4% EVERY MONTH. Annualized that’s a 24% to 48% return and that beats any index fund.”
*If* that’s the whole trading strategy, then it’s a fundamentally flawed strategy. You *cannot* reliably bank 2% to 4% every month without taking the risk of having to lower your strike price, possibly even below your breakeven point.
Let’s take this quite likely scenario.
You buy XHB at $22, and sell $23 calls, banking $1.50. Great. XHB drops to $18 and the option expires. Now how are you going to write new calls? Do you write calls again at $23? No, because those are worthless.
You have a few choices:
1) Write $23 calls for basically no premium. Why bother? You certainly won’t get 2% there.
2) Write $19 calls for perhaps $1.25 and take the risk that they’ll get assigned, and you’ll wind up losing money
3) Hang on to XHB in the hope that it will pop up again to the $23 range.
If you choose #3, which you probably will, you resign yourself to index fund returns. If you choose #2, you run the risk of losing money. If you choose #1, you cap your possible profits for very little premium.
I’m not arguing with the overall strategy, just pointing out that there aren’t any guaranteed profits here. Look at it this way. The bigger the premium you harvest, the bigger the chance that you’re going to miss out on a major jump in the ETF as a result. Options are a zero-sum game, and the guy buying your call has a lot to lose (his entire investment), so clearly he’s banking on some odds of a huge gain.
Everything you wrote is correct but keep this in mind.
1. I have MULTIPLE accounts that I’m trading in
a. Mini
b. Power
c. Arbitrage
2. I’m not putting all my eggs in one proverbial basket so in at least one of my accounts there has been 2% return somewhere every month.
3. Selling XHB calls deep into January 2009 at the $23 strike price will currently yield about 16% right now and it will be irrelevant if XHB drops to $16 because you’ve locked in 16% in 9 months and that’s the alternative - sell deeper calls if XHB drops. You won’t get 16% if it drops to $18 but you’ll likely get 12% (boo hoo still better than index funds).
Statistically speaking, 80% of call options expire worthless so I’m on the other side of the equation - I’ll be called 20% of the time. There are times when I sell at-the-money to hopefully get called and time when I’d out-of-money when I’d like to shoot for a little more.
There’s at least two years of trade history here in multiple accounts and at the end of this year they’ll be three and I have been reliably making the 2% for during that time. Click the links and check out the results.
I would suggest that you paper trade for a few months. Heck, just copy my trades and see what it gets you compared to whatever you’re doing.
And finally, there are no guarantees in the stock market no matter what your trading strategy is and I make that clear on every post with the disclaimer at the bottom.
Again, I’d like to take one more addition to your response (if either of you are still reading this)….
You buy XHB at $22, and sell $23 calls, banking $1.50. Great. XHB drops to $18 and the option expires. Now how are you going to write new calls? Do you write calls again at $23? No, because those are worthless.
Just a re-emphasis that this is an ETF that you would not mind owning for the long haul (or at least longer than the short haul), so - without the covered call strategy, you may have on the same date bought XHB for $22 and still own it a month later with a market value of $18. At that point, your paper losses in the stock are at $4/share. With the covered call sold, your “loss” is only $2.50/share, and as Rich Slick has pointed out, you can still sell another call farther out than just one month. Everything I have read about covered calls - this web site and elsewhere - describes the strategy as “conservative” - it helps mitigate losses and lock in profits. Yes, you may lose out on HUGE gains, but you are also protecting your downside, too.
The key, for me, is in selecting the ETF that you choose to purchase. It HAS to be something that you want in your portfolio - not just the ETF with the highest yielding calls.
I’m still here. I’ve pointed out that there is no “one size fits all” investing solution. If you’re investing money that you’ll need next month or at the end of the year, I WOULD NOT RECOMMEND you use this strategy to invest but if you need the money in a few months, your cash should be in a savings account or CD anyway.
I’m confident of my ability to use this strategy that I’ve borrowed heavily from credit card companies to invest with this strategy after two years of successful profitable results with other accounts. You can see those results here
http://www.etfcoveredcalls.com/arbitrage-account-2007/
but that’s just me.
You could also use the repair strategy if things go bad. Simply purchase one call options and write two with a higher strike price. It lowers your break-even point on the trade and can be adjusted with LEAPS even.
Has anyone tried buying the 2x Proshares up and down of the same index and sell calls on both with equal money in each? I keep coming up with all kids of scenarios in my head of how to do this and make $ just selling the calls. The only way I can come up with to loose money doing this is if one of the ETF’s moves real high way above the strike price while the other direction ETF keeps loosing.
I’ve been doing what you’re suggesting for a while. The key is to buy each at the peaks so buy DXD when the Dow rallies to say above 13k and buy DDM when the Dow drops to say 12k.
This only works as long as we have the seesaw market we’ve had for a few months now. If a strong rally or depression takes hold, it’ll take a while to dig out of the hole.