Wednesday, May 1, 2013


The month of May marks the 4th anniversary of the implementation of a deep-in-the-money covered call option investment strategy that was designed to combat the low interest rate policy by the Federal Reserve, penalizing prudent investors and retirees, forcing them into riskier investments.

Outlined in the 2010 book from Amazon - Zero (In)Tolerance- the plan has performed beyond the expectations of a "hedged" equity investment which caps the appreciation of stocks, but has consistently, in several tested time frames, yielded the historical return (@10%) of the stock market. As illustrated in the book by the "Visible Hand", the five digits show how the strategy reacts to the possible directions of stocks:

* Up sharply, one gives up appreciation but receives the return from dividend-paying stocks (3% or more) plus some premium from the option that is sold 5 to 10 per cent below the initial Buy price. In return, the rising price increases the cushion of safety for when the inevitable retracement/correction occurs. A good recent example of this is Safeway (SWY) which just lost $5 this past week, but is still above the "call-away" price of $21 in the test portfolio - a small IRA that has no contribution or distributions, and is fully invested in DITM. This account is actually up slightly more than the above theoretical 10% annualized figure. Unforeseen was that the current Bull market in stocks actually started in March 2009, two months before the frustration of low rates led to

* Up slightly, in a normal right translation (due to Inflation) is also positive for DITM, again providing the full return expected by the dividend and option price, after subtracting the difference between the Buy price and the eventual price (5 or 6 months out) that it must be "pre"sold at. An example of this is buying XY at $50 and selling a 6 month call option at the 45 strike price, for $6. The $5 "loss" is immediately return (to reinvest elsewhere) and the remaining $1 is added to the return. Done twice in a year with the same money, it becomes "annualized".

* The safest digit or direction of the stock/ market is sideways, wherein at the end of the option duration, another like call is sold (written), while keeping the stock, and avoiding its commission.

* The ideal digit or direction of the stock/ market is slightly down , so that if it descends to where the call was written, on can roll down another 5-10%, six months out and receive a higher % dividend due to the lower price.

* The only losing scenario is the Flash Crash, or Bear market (20% or more), when and if it stays there. Charted examples of these have been: BP, CLF, VALE, and a few more. Even then, one will lose considerably less than someone just long the stock, unhedged. These rare events are balanced out with occasional early exercises, where the profit is improved greatly.

For info on the book, see:

No comments:

Post a Comment