Experienced stock trader and relatively new to F&O. I am mainly interested in covered calls and variations. Been researching and data crunching for months.
I like the concept of Covered ratio spreads, which is basically:
Holding underlying stock + Buying 1x ATM or NTM CALL and Selling 2x OTM CALL and also Buying 1x ATM or NTM PUT and selling 2xOTM PUT.
The idea is to fund all or most of the long ATM call and put premium using the premium from short calls and puts.
Since you are essentially 2 long (stock and long call) and 2 short calls, any move within the short call strikes is amplified (because of the long call)
No Call side risk.
You also make money on the downside(via the long PUT) as long as stock stays above short PUTs, and if your short PUT(1 naked, 1 covered by long call) becomes ITM and is exercised, your cost is reduced by the long PUT.
It appears, even though the Covered ratio spread is not very capital efficient, it has advantages and looks a smart option for people who believe in the underlying stock.
Yeah … It will work. But just like any other option strategy it will work until it stops working few times and it boils down to whether you were aware of the risk, were on the right strike prices and were holding the position or not when things go haywire.
Since, you pointed the advantages, I will just point out the risk. The strategy has -
Negative Vega and
and one will accelerate the other. So, if things go downwards not only you lose on the underlying but volatility will increase and it will accelerate the negative PnL. One can read about those two terms.
Also, it has too many legs. Does not follow KISS principle and can have significant entry exit operation cost. Also, as you pointed out it is not capital efficient especially, if the underlying is stock and not future but even then it will still have 1 extra short leg requiring extra margin.
Frankly, I don’t like to mix equity portfolio with FnO. And in my experience, the concept of free rolling (where the short leg premium from one side is adjusted from long leg) … is too cheesy to be true. It makes you ignore the risk.
Though, I am just pointing out the risk. Don’t let this discourage you and if you find the right strikes, right stock, and do thorough backtesting and then if you see a clear cut edge … it should make money.
Interesting. Thank you for the insights
If one is not shy of taking delivery, the real risk then I suppose is the longer term performance of the stock itself. If assigned, the plan will be to do good ol covered calls.
This is just my opinion. I think the soul purpose of covered call is disturbed here. Covered call gives rental income if stock doesn’t go up as expected, so that atleast small amount of loss can be brought back. In covered ratio spreads if stock goes up it will give you double profit. But if it goes down it will give you 2x loss which spoils the purpose of covered call. You clearly mention in the post that “untill the stock doesn’t go below put bought” not ignoring that point you made. Iam just sharing my opinion not opposing your view. Adjustments can be done if stock breaks the put bought. Even adjustments will be done in covered call. Not pointing out about the 2x loss. I am just sharing that purpose of covered call is not disturbed here.
I love opposing views when I am still brainstorming
I agree there is downside risk. But that should not deter a person who is willing to buy on dips and happy to take delivery. Probably a decent strategy for HDFC, HDFC Bank, Reliance etc… not that any stock is totally immune to doom (ex: yes bank, although I never really liked yes bank),
If delivery is your sole purpose, and the idea is to reduce your cost of purchase, why not just sell naked puts at the strike you wish to take the delivery?
From the most famous investor of the world, who compares derivative to weapons of mass destruction, but still used this strategy to get coca cola at the price he wanted even though the market wasn’t there. You can read about it herein -
Don’t want to hijack the convo but has anyone tried Covered Call using nifty bees? Considering revised lot size, one Future lot would be around 7.7 Lakhs.
a) Indian economy is expected to grow in the long term, so nifty bees should grow as well
b) Can pledge this
c) Nifty is obviously more stable than individual stocks
d) Everything is cash settled, don’t have to bother with giving/taking delivery
a) Selecting the strikes can be challenging. Have seen some people recommending strikes 3% away, some 7%. Subjective call…
b) If Nifty tanks, can give a decent loss (that’s the case with most covered call strategies though)
c) More stable means comparatively less profit, compared to stocks
Just a tongue in cheek consolation especially when nurdled to give up safer option strategies… I decided to track Zerodha’s permissible strikes across days.
An example from last Monday- I could not select 14000, even when Nifty was at 14301.
It’s only when the round number of 14300 was tickled, did we see 14000 open for commoners like us. On the upside, 14750 was the barrier.
600-700 is as narrow as a cult. But I decided to chin up and throw in a few bold predictions that cost me nothing. The suave gambler can never be so delighted when he’s got his task cut.
Voila, Nifty stayed within the median and and ended up at the mode.
Kudos to the constrictions and limitations- we can change real loss into paper profits.