Empirical Evidence of Selling Covered Calls | Trading Data Science

so so the entire world tells you how important it is to buy low and sell high the entire world tells you that try to be different from everybody else yet the minute we go down everybody turns bearish and says the world's crashing absolutely and nobody buys anything just on the way up nobody sells anything they tell you to buy buy and buy higher on the way down they tell you to sell low and so lower sure yet if all things were equal if you were sitting in a party or they get together and you were at the coffee table and you're sitting there toilets it well yeah of course you should buy when things are cheap Gordon actually comes to doing it they can't do it you know why cuz none of them trade right do you know why cause none of them ever use their own money you know why cuz they're all gutless they are absolute freakin guns this whole industry is gutless how do you really feel about this nobody buys anything when it goes down and nobody sells anything that goes up and then everybody just all rest the time how come because they can't outperform whatever I'll share sure absolutely freakin gutless and I mean we've gone down close to 10% and just you know the first week of the year if you still think because everybody remember the barons round table at the end of the year in everybody talks about what their projections were for next year yeah so every rejections were for unchanged top 10% sure apparently so if you were down 10% you're doing a 20% discount or a 10% discount at the least exactly yeah and is anybody buying what you know waiting for a reference they're all they're all godless I'm telling you sure they are not only gutless they're all liars they don't actually plan to execute what they talk about sure if you said in December when the mark was strong to all those people sitting at that roundtable that if you said to them at that point if the markets down 10% the first week of the year would you buy it I'll go tell her hands please our hands please now that we're down 10% what do they say hold on Sparky eight there you go gutless liars the whole business and and all of them if you haven't if I if you ever see me okay ever give anybody a dime to manage your my money just run you over just come up here drive the car inside the building of on me over okay cuz that's what it is yeah okay alright I'm done with that little speech good job better you um here we go the skinny and options data the data around selling covered calls high implied volatility low basis this is what your this is this is what you do this is what you do yeah and and maybe it's still early you know maybe there's another container twenty percent for the market to go down low 800 laptop no wonder you losing a laptop this time on this laptop this time we're gonna use the laptop cover called writing is on average a profitable strategy why is it a profitable strategy oh you want to find out I want to know why it's profitable strategy why you can make a statement like that that you can say on average it's a profitable strategy how could you say that well we can we can look at the numbers okay I don't here in a little while but it's it's it beats over time it's it's beating just 50/50 to make to make sure successfully diminish so that's the answer you up some upside and return for us greater than 50/50 statistical chance to success forget about everything else mmm-hmm you give up in layman's yeah what can you say about its performance if we look it's solely at the empirical data for the empirical evidence how about during different market conditions so let's take a look how does perform during bull and bear markets for example the strategy relies that implied volatility overstating actual volatility this will most likely continue into the future which means forever in fact it's funny there was an article in there was an article pushed out by Goldman Sachs the other day I think they were the co-authors to and they talked about real they talked about volatility verse real volatility in 2016 they were making the argument for the same thing they obviously watched one episode of tastytrade and they kind of got it but they didn't quite get it all the way sure and and so they decide to write a right article about it absolutely otherwise you know who would sell you uh you know premium for example of course of course so so what do we have here okay so this is just you know in yellow that's implied volatility and then what actually occurs after the fact you know the realized volatility of the market and you can see that for the most part except for some you know um points in like 2008 for example you know the most part implied volatility over states actual volatility the market does not move as much as what's anticipated or feared if you looked at that and you said would you rather sell the yellow and buy the purple or would you rather sell the purple and buy the yellow I think you would say I would rather sell the yellow and buy the purple absolutely isn't that that's what we do since we sell to yellow you buy the purple got it and it occurs because you know people like buying hedges protecting against the positions a buddy of mine we're talking last night for a long time because he's he believes that we're about to enter a period where liquidity may be one of the issues okay he's like Tom you know you gotta be really careful here because because we face some potential liquidity crisis and I go okay I understand so he's like well how do you defend how do you tell your viewers how do you gonna defend against a liquidity crisis and I go well the only way you can just provide as well just by saying small yes I mean unless you want to sit here and and you know like the same thing as saying well it's supposed to it may rain today or it may you know we may experience some kind of a current odd right whatever it is sure but does that mean you know quite your house there's a horrible terrorist attack last night in Indonesia Jakarta and some crazy nutcase like it's always the case or you know um you know started blew themselves up in a couple of nut cases and blew themselves up and and I think six people died another you know just and and the the president of Indonesia you know basically settings president but said listen go here the first the great answer which is don't do anything different of course okay don't do anything different you know leads your normal life don't let any can anticipate it that's right and and and and again I think you you always trade your normal trading style you know he's just you can you can be smarter about things you can say smaller about sheriffs but you can't predict something like you're not gonna never leave right again press you're worried about you know a terrorist hanging out outside of a suicide bomber hanging outside of a Starbucks she absolutely it's the same thing here you can't worry about liquidity going to zero or something happening that that you have no control over it's the whole fooled by randomness argument I hate it because you have to go about doing what you do mm-hmm just stay small that's it percentage of days implied volatility overstated actual volatility 30 days out and that's a fascinating statistic mm-hmm so what I did is I just looked at all 500 stocks in the S&P 500 that have options and look to see okay how often the actual stays within the implied and you know this to me this is almost backwards right I mean I'd almost expect to see that the individual stocks are less efficient than the overall market when reality people are using the indices for hedges and so that's one of the reasons why I implied volatility seems to spike from those individual products now the implied volatility is is less in those products you know the indices because it's it's a group of stocks as opposed to individual stocks and so you have a less individual company risk but at the same time the market does tend to stay within those implied bounds more often in the indices it's there has been a trend over the last couple of years and it's more pronounced now than ever especially the article that was written the other day I think was Bloomberg but a camera where was talking about how 70 70 something percent of notional trading takes place in ETFs right now Balam and notional notional dollars and and listen people are smart that's it I mean like it's not it's not that we've just gotten smarter yes we've just got smarter we understand you know where the liquidity is we understand where the you know where the best opportunity is and you know and we're the depth of market is okay I mean I just bought some meds that he had Apple taken down I put a buck and a half two so yeah I don't care about that no I'm saying it's wasn't okay I mean I think a great example right now is like xop instead of buying one individual drooler yes there's a lot of risk in that you can offset some of that risk by buying that entire actually I mean if you really like a stock sure you go for it because because you're gonna get a much higher beta and you're gonna get more bang for your buck um but sure quicker bang but the industry right now is in such turmoil and there's definitely individual stock risk but but but if you want high bond high implied volatility and you want low basis I mean you know it's way different buying stock at 23 than it is buying stock wooden was 70 yes I mean some points ago it was 70 yes three different strategies will be compared holding the sp500 including inclusive of all Tivat and holding the S&P while selling the anthem oni call and holding the S&P while selling an out of the money call at 30 deltas and this is the sp500 Total Return Index typical S&P 500 index should not be compared because it doesn't include dividends you're exactly right I mean the you know around 50 percent of the gains within the S&P 500 have been because of dividends you know so you can't exclude those that dividend component even though dividends right now are not a huge component you know the SMP historically they've been sure a greater so this is a fair comparison sure and yeah I don't as long as it's consistent I couldn't care less absolutely so this is just showing the three different you know examples and so I'm showing since 2000 selling the 30 Delta cover calls is not performed you know right 30 Delta you're just buying or you're selling that call just a little bit out of the money as opposed to add the money where you're selling it you know right on the last sale it's the CBOE has some nice indices that you can look at to see how well these strategies have performed the selling the you know at the money that that's bxm so you can look that up on your your yeah I'm fascinated by the fact that that so many people in this industry will sit there round and go loosen the best thing you can do is is invest in the Vanguard XYZ stock you know benchmark fund and then and then fall into a coma for 20 years that's the best you do really it's not the best you can do because even this index here wants to just say this so I'm the 30-day covered call which is an index you do this and you Val performance and this is not a tradable index that's not what I'm saying here yeah in DSS and the prim stance but this it's the you know there are versions of this that are trade up it are terrible but anyway it gives you a really good really clear picture but you can do it yourself you don't have to pay somebody to do that for you you can see how the strategies have performed using different market conditions by dividing the the S&P 500 Total Return Index what does that mean okay so what we're trying to do here is we're trying to see how all those strategies have performed here in different market environments when you take out the effects of the overall market right and so we just want to be able to just look only at those specific products exclusive of the the overall effects of the market so I want to see and then we can kind of pinpoint okay this is a bull market this is a bear market and we can see how well they performed so during that bull market of roughly 2000 to 2003 to 2007 you can see covered call writing underperformed the S&P long just holding a long position is always gonna perform better in a bull market you still make money you just don't make as much money you know you're basically buying a little bit of protection for yourself a little bit of downside protection and but you're kind of capping your gains a little bit and then during bear markets you can see it really outperforms just holding an outright long position you can see it going up and then because like I said this is only the effects of the covered calls the the different strategies we're taking out the effects of the overall market here and so during that last this is just the overlay yes this is over like so during that that bull market that we've seen up until 2015 yeah and who knows it may continue to be a bull market but you know the cover call writing it has underperformed the market it's very hard to outperform the market but you can also see that you know when you've did the the the 30 Delta switch is a little bit further out of the money you perform better and selling at the money yeah I don't know if I fully understand this because I get clearer in the in the next few pictures cuz that's a hard one taking out the market trying to figure out so performance during pull markets the long stock outperforms covered writing yes but I say here that you know your probability of having a profit during any individual week or being higher your P&L then the previous week is actually quite a bit higher here sixty-five percent compared to just having a long stock position so yes you underperform just a little bit but your probability of success is actually greater and this is what shows you know so you are capping you're upside just a little bit but you got that premium going in your favor yeah I don't I don't even know if I agree with us but um but so this just shows during that last bull market now and this is just showing a comparison of all three right so in the first one what what performs best is the Total Return Index you know just holding the SNP collecting those dividends is gonna perform a little bit better you know as a strategy during a bull market even though our probability of success per week is less and then you know writing that 30 Delta a call is outperforming selling at the money is because at the money's are gonna turn to in the money's if the market continues to go up alright okay so what's to say and and how do you know that you're in a bull market although these are money calls this is 30 days mm-hm this is 30 days yeah this is how the CBOE indexes is created performance during Bear Marquez this is really when covered writing outperforms so if you're you're scared about the market you want to protect yourself from the downside a little bit all at the same time still participating in the upside that's if you do have a bounce this is a covered writing is really where it's at you can see the selling the at the money covered call you're bringing that call closer to where you are performs 53% of the time you have a profitable week whereas long stock in a downward-sloping bear market is only correct about 44% of the time okay it wasn't aware of those actual numbers and so here you can see during the 2007 to 2008 of you know bear market you can see that the total return index that purple 2008-2009 and I standardized the prices right so I started at a hundred it went all the way down to sixty so you had a position that was at you know ten thousand dollars now you down to six thousand dollars if you just tell the the Total Return Index now if you if you think you're going into a bear market you obviously sell your stock you know that's that's gonna perform best because you're flattered but how do you know you know your your told your market right you don't and you want to be able to participate you don't want to sell right now I mean because the markets already come down but you may want to cap any potential loss or not cap but reduce or cushion any loss and so that's when the add the money covered writing works better so the takeaway is it's hard to outperform an outright long position in a bull market but covered calls do provide a greater percentage of profitable weeks and I think most people would up for greater percentage of profitable weeks I would I would if you were bearish sell stock but you may be wrong and miss out on further upside so a better alternative is to sell at the money calls in fact somebody emailed me this morning they said Tom I'm I'm I'm not bearish but I and I don't want to give up my positions but I'm nervous so should I sell in the money calls or at the money calls and I said well either one but I'd probably sell out the money calls for the greater premium but I mean that's what people are thinking which is good yeah absolutely and then there's some place in between too right yeah um yeah you know I might not sell at the money that's cell 30 I might sell somewhere in between yeah got it all right beautiful thank you of course good job out of you yeah good job we went a little over so but I think it's I think a lot of people like the covered call angle I think so too yeah we'll take a quick break we'll come back we got a market measure next stay in the course understanding probabilities to trade live what's up everyone thanks for watching our video click below to watch more videos subscribe to our channel and visit our website at tastytrade calm

Channel: tastytrade

Views: 45,511

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Keywords: Options, Covered calls, premium, Michael Rechenthin, data science, selling calls, writing calls, covered call writing strategy, Skinny on Options Data Science, tastytrade

Id: -IE1QM-DdtI

Length: 17min 36sec (1056 seconds)

Published: Mon Apr 18 2016