Delta Variant Made For Interesting Option Trading Results For 2021 3rd Quarter

Summary

• As the quarter proceeded, so did concerns about the ill effects the COVID-19 Delta variant was having on the health of the world’s population and economic activity.
• Two stocks perceived to be most affected by the Delta variant performed poorly and resulted in those Put trades being exercised against me (LUV and SLB).
• August presented two opportunities to profitably exit trades.  I included a section on the thoughts behind my actions related to both positions.
• This article covers all the option trades I made during the 3rd quarter of 2021.  I also cover a new option strategy I used. Overall, it was a good quarter.

AndreyPopov/iStock via Getty Images

Introduction

Data by YCharts

Two factors help set option premium levels, interest rates and market volatility. Of course, a stock's volatility is what matters. Interest rates, having declined from early 2021, did not move much during the third quarter, ending about where they started. While market volatility rose during the quarter, hitting its high near 27 in late September, that peak was below the ones reached over the past year. The market's low volatility means picking stocks with higher risk in order to achieve 10+% ROIs.

This quarter saw both 27 trades executed (22 Puts, 5 Covered Calls) and the same number of trades closed (25) or exercised (2). With me now owning three stocks from writing Puts and my belief there is better long-term risk/reward outcomes by not becoming a long-term shareholder, I adopted a new tactic regarding these stocks, which I explain later.

As a reminder/disclaimer: Option writing is not for every investor. Second, there are many strategies and uses of buying and selling options, several of which I will provide article links for at the end. For beginners, here are four articles I highly recommend you read before trading:

Options 101 – A Beginner Guide To Options

Don't Trade Options Without Studying Greek(s)

10 Rules For Option Traders

Mistakes Made By Novice (And Maybe Seasoned) Option Traders

Writing Covered Calls with a companion Put

I am sure there is a proper spread name for what I am doing. Before this quarter, I would write Calls with under a month's remaining life, using a strike price at or above my cost. This was working well with the Cracker Barrel Old Country Store (CBRL) stock I was Put to last quarter, but since I was willing to take the added risk of owning the shares, it made sense to add to the premium income from the Calls by writing some deep OTM Puts.

The number of Puts depends on how many shares I already own and the most I would want to have if Put a second time. In the case of CBRL, the strike spread has been $25, about evenly split from the stock price when written. Premiums on CBRL are good and four completed trades have made $945, with three trades set for expiration in October. Weekly options with good volume on both Southwest Airlines (LUV) and Schlumberger (SLB) have made the strategy easy to execute against these stocks I was Put to this quarter. Across all three, their cost has dropped enough to use lower strikes on the Calls.

Closing trades out early

Different option traders have different rules, or none at all. Several have mentioned they will close out a position once they have captured a set percent of the premium written, usually between 50-75%. I have closed early if the remaining ROI was below 3% and there were better opportunities to redeploy the underlying funds.

Another popular strategy comes into play starting about ten days before expiration. If the option is either deep ITM and getting exercised is okay, nothing to do. In the cases where the actual price and strike price are close, the trader needs to reevaluate their situation. If sitting on a profit, it is easier to close out as no one wants to admit to a losing trade. A more important input is the perceived risk/reward for holding until expiration. As the August monthly expiration approached, I had two contracts in this last situation: both just above the strike and would turn a profit.

Data by YCharts

First was my Cracker Barrel $135 Put I wrote as part of the Call/Put idea discussed above. Since I had 200 shares and the price had been dipping below the strike price, I closed out, netting about 60% of what I could earn if the option expired OTM. I earn $125 versus a potential loss of maybe $300. While the option did close OTM, before expiring, CBRL briefly sold for under $130, which would have been a $625 difference from what I got.

The second was my 4 Puts at $27.50 on Schlumberger. I have successfully written Puts against SLB since April 2020. Here I chose to hold on for three reasons:

1. I did not own any shares and execution would be only $11,000.
2. SLB had not broken below $27.50 in over a month.
3. Call premiums were rich if I took possession and needed to Cover, my usual strategy when Put to.

As you can tell from the chart, SLB closed below the strike and I was put 400 shares. My net loss was only $.10 per share, versus a potential gain of $.60/share if I sold on the day I decided to keep the options. While in hindsight, I should have done the opposite in both cases, the key was I reexamined my positions and made decisions based on expected risk/reward at that point in time. Another strategy would have been to "roll" the options forward.

Third quarter option trade review

To allow comparison between each trade, the ROIs are annualized. The shorter the time the contract was open, the harder it would be to constantly write new contracts and maintaining the same ROI for a full year.

Southwest Airlines (LUV): There was no love for this Put trade: "buy the rumor, sell the news" truly applied here as the stock fell even as the economy reopened. My early JUL $57 Puts (3 contracts) were Put to me as the price dropped from over $61 when they were sold to $52.84 at expiration. These were Puts I wrote with less than my usual 10% OTM margin to enhance the ROI (14% if expired OTM). I chose to take possession versus closing out with the expectation the price would hold steady and the Calls were showing the ability to recover some of the lost ground. In the meantime, the actual trade ROI was -59%. My two sets of expired Calls earned 7.83% and 12.36%. I have both Calls ($55) and Puts ($45) expiring in early October. Net effect is my break-even price is down about $2.

Amgen (AMGN): I already own 50 shares of Amgen and sold Puts to possibly pick up another 100 shares. It adds a nice diversity to AbbVie I write options on and adds another drug company to my list. Here wrote 1 JUL $235 Put when AMGN sold for $258. Despite willing to own this stock more so than others, I chose to stay with my 10% OTM strategy expecting a market correction. It did approach my strike but rallied to close at $248 at expiration. The trade earned a 7.93% ROI. One thing I do upon expiration, is look to see what’s available to reopen a position. With VIX down and drugs stocks normally less volatile, nothing had an ROI worth the risk.

AbbVie (ABBV): This is the second drug stock I use for Puts with the idea of picking up my first shares. Like AMGN, new trades are currently unappealing, so I have decided to move on. Here I wrote 2 JUL $105 when ABBV was at $117. It closed at $115 and the trade earned a 6.91% ROI. Like AMGN, premiums were too small to worry about and the possibility of a large inflow of drugs stocks from my folks has me forgetting about drug stocks at this time. My medical attention has shifted to two ETFs.

TravelCenters of America (TA): TA runs one of the largest networks of interstate travel centers, mostly catering to truckers. As an investor, my first trade was buying its 2027 baby bond (TANNI) for my bond ladder. The 2 JUL $22.50 Puts were actually my second trade as I had already wrote some September Puts. COVID19 risks to travel and some weak financial has kept TA’s volatility elevated (67%). Even with going 17% OTM, the trade yielded a 15.38% ROI. My 2 SEP $20 were left in the dust after the earnings report as TA soared to over $45 from the $25 when the Puts were sold. The risk at the time is obvious based on the ROI: 17.86%. I never got the nerve to write another set.

Willis Towers Watson (WLTW): I use the services of WLTW to help manage my retired health plan enrollments. AON was in the process of trying to take them over which added extra downside protection versus the tight spread I wrote ($210 strike when WLTW sold for $225 but takeover value was close to $240). Options were hard to trade so attempting to exit early was not possible without giving up a large part of the ROI. In June, Europe tossed uncertainty into the deal closing but the option did expire OTM. The trade earned a 12.06% ROI. Spreads in July were too wide to attempt another write, and then the merger was canceled due to US government opposition. WLTW has done very well since; currently over $230.

Cracker Barrel Old Country Store: I picked up 200 shares when my JUN Puts expired in the money. My usual strategy is then to write 2-3 week Calls at a strike that would allow the full trade to break even. Here I have to go out one month as weekly options do not trade. Here I write 2 Calls and 1 Put every month and this has dropped the break-even price by $5. The four trades done so far have average a 13% ROI. This strategy was covered earlier in this article.

ONEOK (OKE): I started writing Puts against OKE in the second quarter as its volatility allowed for good ROIs and reports on the company have been favorable. Since then, earnings have come in better than expected and the stock has traded in a narrow range. Having weekly options is a plus as I can avoid 3^rd Fridays. The first trade this quarter was the 8/6/21 $51 strike, which I wrote 3 contracts. That one expired OTM and yielded a 16.12% ROI. The second trade was 4 Puts using the $49 strike, expiring on 9/10/21. Again closing OTM, this trade yielded a 19.42% ROI. The next set expires in early October.

PNC Financial Services (PNC): This bank continues to have higher volatility than many stocks on my radar. The first trade this quarter was with the AUG $170 Puts sold on 7/8/21 when PNC was at $183, a smaller OTM percent than usual as this is solid a bank that should benefit if interest rates ever go up. PNC remained above $180, earning 12.95% ROI. I have chosen to write 2-3 month options to reduce the trading required. The next set expires in early October.

Vanguard Extended Market Index ETF (VXF): I was writing options that expire each month on this ETF as a means of ownership and the desire to lower the cash held in one account. Low volume has me using 2-month options now but for more contracts. VXF invests in the market below the Large-Cap stocks represented by SPY, and this is an asset class we are under invested in. The AUG $175 Put, purchased when VXF was at $183, generated a 9.67% return, a period when the ETF showed a negative return. For September expiration, twice I wrote a $175 Put while VXF was over $180. The ROIs on those trades were 7.9% and 5.15%, respectfully. I held 40% of the open contracts on expiration day.

National Health Investors (NHI): I wrote Covered Calls on my long-term holdings as I decide whether to keep or sell. NHI cut its dividend last spring and is still having issues collecting rents. Expectations were for a good 2Q earnings report so I wrote $70 Calls with NHI at $67.67. The report wasn’t good and NHI was down to $59 at expiration. I netted about $102 with an ROI of 11.93%. At the current price, I am not willing to write the $70 Calls I would use.

Wyndham Hotels & Resorts (WH): I first wrote against WH last winter when hotel premiums were still high due to lock-downs. The August write of 3 SEP $65 Puts was my reentry for WH. While risk was down, it was better than other stocks as the threat from the Delta variant was rising. WH did not move much during this period, closing about where it was when the options were written: $72. The ROI on this trade was 9.52%.

ARES Capital (ARCC): Ares Capital is one of the BDCs I own that adding more shares would be great. Like most BDCs, the option volume is low and bid/ask spread wider than most options, making it difficult to sell contracts. ARCC moved from $18.92 when Puts were sold to $19.89 at expiration. My 4 SEP $18 Puts earned 10.92%.

iShares Frontier Markets ETF (FM): FM is another tough ETF to try writing options against. I was 3 of the 4 contracts open at expiration and was 100% of the volume when written. This trade was to possibly add shares to my existing holdings as Frontier Markets have good demographics for GNP growth.

The Bottom line

For the quarter, I earned about $6400, $5300 accounting for the two Puts exercised against me. That resulted in a quarterly ROI of either 10.2% or 8.5%. I calculate that based on the $250,000 in cash set aside for Put writing. I don't adjust the base for cash not employed nor the value of the stocks now owned via Put exercises. Both are my choice; others might do otherwise.

Open option contracts

All Puts except: SLB $30s, LUV $55s, and CBRL $150s

Portfolio Strategy

If you have an investment strategy, there probably is an option strategy that can be used to enhance its outcome. If you have investment goals, I bet there is an option strategy for each one. Each has their own risks and your broker is obligated to send you the Options Clearing Corporation's The Characteristics & Risks of Standardized Options pamphlet that covers all of those risks.

I have chosen to mainly be a writer, mostly of Puts, to enhance the return on the cash I have chosen to hold, being rather conservative in my overall investment strategy. My goal is to earn a 6-8% annualized return. Knowing what you want options to do for you will determine how to employ them.

Here are links to option strategies I have written about:

Writing options for income (my main one used)

Adding Leverage via Options

Using limited cash to increase your equity exposure

Option strategies for down market

Analyst’s Disclosure: I/we have a beneficial long position in the shares of CBRL, SLB, LUV either through stock ownership, options, or other derivatives. 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 also have open option positions in the list shown in the article