- High volatility produced some outsized ROIs when selling options during the past 12 months. Unless things change, that train has left the station.
- Low volatility means writers have choices: Stop writing; Accept lower ROIs; Take more risk. There is a 4th choice that I picked: combining low ROI trades with higher risk trades.
- I will cover why I write options, review my first quarter trade results, and give readers what I see for the second quarter, including trades already open.
They say a picture is worth a thousand words. The above chart explains why today many stock options provide returns that are a mere shadow of what was available last spring and into the fall of 2020. Yes, many companies heavily effected by COVID19 lockdowns continued to sport higher volatility scores up to the 2020 US elections, but with the release of the vaccines, most of those risk premiums have dried up. REITS and special situations were the rare exceptions by the end of the first quarter.
Why I trade options
Different investors use options for one or more purposes, such as trading with leverage, trying to buy below the current market price, downside protection, or like me, to generate income. While I will write Covered Calls occasionally, most of what I own do not have active option contracts to execute against. I use a very conservative Put writing strategy that should allow me to earn a ROI of 6-8%. While I am retired and enjoy the safety of cash, I also do not want it sitting there earning next to nothing.
Regardless of why you trade options, either as a buying or a seller, have a plan in place and be willing to stick to it even when you have a trade that does not work out. Here is my plan:
Keep learning what the option data points mean, represented by various Greek letters.
For writing Puts, have enough cash to cover each trade in case I am required to buy the stock. I have strategies in mind when Put to.
Write Covered Calls only at a strike price I am willing to have the stock Called at.
Write Puts on stocks I am okay owning at the strike price chosen. Violate this only if the potential ROI is large enough and the risks are apparent.
Use a conservative approach by selecting strike prices that are 10-15% OTM. While this reduces the ROI, it increases the odds of not being exercised against - that's the trade-off.
As much as possible, stagger the expiration dates so I am not scrambling to write lots of options the following week. With some stocks now having weekly options, this has become somewhat easier to accomplish.
All these points and a few others were covered in more detail in my 10 Rules for Option Traders article.
Option Trade Summary
I can divide my trades into several strategies: Income Generation Focused or Income/Ownership Focused. The first are designed to generate return on the cash I want to hold in each account I write options with. The second are assets I am either trying to add to an existing position or for establishing a new position.
Income Generation tickers-Covered Calls: NHI
Income/ New Ownership tickers: ABBV
I have added another group that I am okay owning but are higher risk/return stocks. This list currently includes: CC, GDRX. When a merger opportunity option trade exists with a decent risk/return outlook, I will consider it. Currently I have one open: WLTW.
1st Quarter option activity
To allow comparison between each trade, the ROIs are annualized. The shorter the time the contract is open, the harder it would be to constantly write new contracts and maintaining the same ROI for a full year.
Iron Mountain (IRM): One of my favorite REITS to write Puts against as the risk/reward is still favorable. IRM is trying to add digital record storage to its product mix and that has some investors nervous which helps elevate its volatility. I wrote 5 Jan $22.50 Puts when IRM sold for $26. At expiration it rose to $30 and the trade earned a 10.57% ROI. I then wrote another set, Mar $27.50, selling 4 Puts when IRM traded at $30.30. These expired OTM and earned 15.86%.
iShares Gold ETF (IAU): As mentioned, I will write Puts on tickers I already own as a means of possibly adding to my position but at a price below the current market price - this is one of them. I usually write 3-month options on IAU because they are difficult to trade (low volume/wide spread). Being an ETF, the ROI is usually low, even using a strike price close to the actual market price. Here I wrote 5 Jan $17 Puts when IAU was at $18.25. It fell from that point but was OTM at expiration, earning me 5.12%.
PennyMac Mortgage Trust (PMT): Because this REIT focuses on mortgages, it often has higher volatility, resulting in decent returns. On the downside, the large dividend payments mean avoiding those ex-dates when selecting which expiration date to use. This time I wrote 4 Jan $12.50 Puts when PMT was selling for $16.60. It closed slightly higher. ROI on this trade was 9.73%
Ares Capital Corp (ARCC): This is another one I regularly write against and a BDC I do own. Like PMT, its high yield again means avoiding the ex-dates. I wrote 5 Jan $13 Puts when ARCC sold for $13.98. Being one of the tighter writes for the quarter, it had the second highest ROI at 16.05%. I replaced these with 5 Mar $15 Puts while ARCC was at $17.20. This trade shows the effect a drop in volatility can have as it earned only a 5.9% ROI.
VanEck Vectors Fallen Angel (ANGL): This is another ETF that is hard to write Puts against so I again use longer-date contracts. Here I wrote 2 Jan $29 while ANGL traded at $30.02. ETFs usually have low ROIs as was the case even with another tight write: 7.05%. This another one I am trying add shares to an existing position.
One thing the above three tickers have in common is their price movements will be influenced by the rise and fall of interest rates and perceived strength of the economy. Using IAU helps offset that risk as Gold usually does better in that environment.
Huntington Bancshares (HBAN): These were written to offset the Covered Calls I wrote on HBAN and worked as planned. They offset some of the loss I incurred in December when my shares were called early. While HBAN options are also tough to trade, the Puts always had excellent returns. My 3 Jan $9 Puts, executed when HBAN was at $9.95, earned 22.99%.
National Health Investors (NHI): NHI was the only Covered Call I opened in 2020 that was not called. The stock has rallied from the mid-$30 to above $70 before drifting back some when the Options expired. My Jan $75 Calls, written when NHI was trading at $62, return 5.76%, almost like adding a 5th dividend even with the high OTM percent used. Surprisingly these options are lightly traded and I haven't written a new set as the return is too low for the risk taken.
Wyndham Hotels (WH): This sell was initiated in early October as news of possible vaccines being available by year-end started circulating. Like most stocks effected by lock-downs, the premiums were generous as the volatility levels were still elevated. I wrote 3 Feb $40 Puts when WH was selling for $50. A cautious trade just in case things did not improve. They did and WH closed above $60 at expiration. Even with using a 20% downside trade, I earned a 9.44% ROI.
AbbVie (ABBV): ABBV has a great track record and nice yield (4.9%), so this one is on my buy list. Even so, I stayed conservative with the election still in the future at the time of execution. I sold 2 Feb $77.50 while ABBV was at $84. ABBV rallied with the other drug stocks and overall market to close near $105 at expiration. One risk of using Puts to purchase is the stock runs away from you. That said, the trade yielded a 12.37% ROI.
Pembina Pipeline (PBA): I did buy 100 shares to add to those already owned. I also sold 5 Feb $22.50 Puts when PBA was at $26. One issue with selling options on lower priced stocks is the standard $2.50 between most strike prices can force you down farther than desired to avoid a strike price a little too close for comfort, in this case the $25s. PBA close slightly higher at $27.23, netting a 12.50% ROI.
Schlumberger (SLB): With the "greenies" running wild, premiums on most fossil fuel stocks are above what is available on many stocks. SLB has been a stock I have been writing Puts against for almost a year now. This time it was 5 Feb $16 Puts while SLB traded for $18.54. The elevated volatility shows in the high 20.5% ROI this trade earned as SLB closed over $27 on expiration.
Walgreens Boot Alliance (WBA): I had all my shares called last quarter that prior Put trades resulted in my becoming an owner. With premiums better than CVS, I decided to stick with WBA for my drug store stock. I also like the fact they have weekly options, allowing me to stagger their expiration away from 3rd Fridays. This time I wrote 3 Feb $34 Puts when the stock was at $38.50. With vaccines being available via drug chains, the stock rose to $48 at expiration. This option trade earned a 9.44% ROI. I then wrote some Apr $42.50 Puts to replace them.
PNC Financial (PNC): PNC had a good write-up on Seeking Alpha in January. Being from the East, I was aware of this bank for a long time. I wrote 2 Mar $142 Puts when stocks were looking weak and PNC was trading at $157 after trading as low as $143 the weeks before selling the Puts. PNC never looked back and closed at $181 on expiration, netting me a 9.54% ROI on the trade. Another reason I like PNC options is they have weekly ones available.
iShares Frontier Markets ETF (FM): FM moved sideways most of the quarter, remaining well above the conservative strike used. My 4 Mar $25 Puts earned 5.76%. These are also tough options to write due low interest as reflected in the fact I owned 80% of the open contracts at expiration.
Main Street Capital (MAIN): MAIN is one of the BDC I like writing options against but the price now makes it tougher finding a strike to use as the gaps over $30 are $5 on most expiration dates. This caused me to go deeper OTM with this set, writing 6 Mar $25s when MAIN sold for $31. MAIN now is over $38. ROI on this trade was 6.6%.
Extra Storage Space (EXR): One of the few REITS with options with any volume, and these are slim too. There were only 78 open at expiration. I wrote 1 Mar $100 while EXR was at $114. EXR was $128 at expiration, earning this trade an 8.36% ROI. This was the first time I sold Puts on this ticker.
Cracker Barrel Old Country Store (CBRL): This set was sold as the vaccine roll-out was underway. I wrote 2 Mar $110 while CBRL was at $135. The wide spread reflected concern it might have already reflected better times, but it hadn't as at expiration it sold for $171. Even so, the 10% ROI was one of the better ones for those expiring in March.
iShares Russell 2000 ETF (IWM): For an ETF, this one has good volume and a decent volatility score. I also like it as it has quarter-end dated options. This is my second time using them. I wrote 2 Mar $155 even before the December set expired to capture two extra weeks of time premium. IWM was at $190 at the time and I was convinced (wrongly) a correction was near, figuring all good news was already reflected in the market. That pessimism resulted in a low 4.74% ROI.
Kodak (KODK): Last August, I sold 5 Jun21 $2.50 Puts during the great debate over whether the recently announced deal with the government was legal or not. Since then, KODK has bounced between $5-$12 a share. Even though KODK was only down to $8.33 in late March, I decided to close out my contracts for $.07, which allowed me to capture over 90% of the premium and close out 3 months sooner. ROI on this trade was 41.13%. Would they all be so profitable! I calculated my ROI at 32% if held to expiration.
No trades were Put to me in the quarter nor Calls exercised against me. I earned $5307.86 for the quarter, amounting to an annualized ROI of 8.5% on the average cash or stocks securing the trades.
Open Option Positions (all short Puts) at Quarter-End
This will give you a good idea of the OTM depth I use and the typical contract length used, though all do not expire on the 3rd Friday. With more stocks having weekly options available, I am able to spread the expirations throughout the month. Every Friday in April has at least one option expiring.
First off, a reminder that option trading is not for everyone. If you have never traded options before, please read up on the various strategies and my articles on the Greeks and Trading Rules mentioned earlier in this article.
Despite lower volatility, my goal for 2021 is still to earn a 6-8% ROI. To achieve that ROI this year, I need to earn $3750-5000/quarter. I believe, while achievable, it definitely will be more challenging at current volatility levels. My currently open contracts for the 2nd quarter will generated $3700 if all goes as planned.
My 2021 Outlook and Option Strategy
To help me achieve my income goal from option writing, I will focus on:
- Adding to my possible optionable stocks some that still have elevated risk premiums which will help.
- Keeping a better eye on having all the cash available to be Put against covered by open Put contracts.
- For stocks I want to own, write options less OTM, thus adding trades with higher ROI potential.
- Consider executing Buy/Write trades on stocks that would also generate dividend income as part of the trade's ROI.
You might have noticed I seldom report trades where I am the Buyer. Those trades require you to be right on both direction and amount of price movement to profit and I do not feel that is in my knowledge bank at this time. I also currently don't use Put options for Bear market protection; I know other option players do. Instead, I have chosen to maintain a low equity ratio as my means of protection. Of course, having open Put contracts, as I had in the spring of 2020, will prove costly. As they say, there is no free lunch.
Closing Thoughts for other Option traders
- Know why you are trading options, either as the seller or buyer. The three linked articles above are some of the reasons investors trade options.
- Remember to use stocks and strike prices you are comfortable with. Even though you are option trading, due diligence of the underlying asset should still be done.
- Do not have more open contracts than what you can actively monitor. The best trade sometimes means pocketing your profit before the option expires.
- Finally, if you are not having fun, stop trading options! It is not worth the heartburn.
This article was written by
Retired Investor has been investing since the 1980s and has a background in data analysis and pension fund management. He writes articles to help others prepare for retirement by investing in CEFs, ETFs, BDCs, and REITs. He is a long only investor and shares strategies for trading options with a focus on cash-secured-puts.He is a contributing author to the investing group Hoya Capital Income Builder. Hoya specializes in the portfolio management of publicly traded real estate securities and dividend ETFs. Learn more.
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
I have an short positions in every option listed under Open Contracts.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.