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bender

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« on: June 11, 2017, 06:51:00 AM »
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« Last Edit: March 30, 2018, 07:56:21 AM by bender »

Financial.Velociraptor

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Re: Selling call options on QQQ to diversify
« Reply #1 on: June 11, 2017, 08:43:50 AM »
I try to sell options on everything in my portfolio except fixed income allocation.  It reduces risk, lowers volatility, and provides a nice return.  I also recommend a trailing stop loss on the QQQ position.  The cube is volatile and got whacked hard in the dot-com crash.  You don't want to ride it all the way to the bottom.

StreetCat

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Re: Selling call options on QQQ to diversify
« Reply #2 on: June 11, 2017, 03:29:42 PM »
If you are trying to avoid paying taxes, selling short term options (and making profit on those options) will do the exact opposite.  You will end up paying short term cap gain taxes on expired options.

Instead of that, calculate the number of QQQ shares every month (or every quarter) that would give you the same amount of money as the option premium would, and sell the shares.  Since you mentioned that you've held QQQ for many years, you will only pay long term cap gains tax.
 
If it goes up, I'll pay to close the option, which will eat up a portion of my premium.  If tech rallies, I'll be paying out of pocket to close the option. 
I don't think this is a good idea.  If you pay out of pocket and buy back the options, the following month QQQ may go down.  You didn't lock your profits this month when QQQ was up.  And then you will lose those gains.  And this can keep happening month after month - you sell the option, QQQ rallies, you buy back the option, then QQQ goes down again.

Inquisitive1

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Re: Selling call options on QQQ to diversify
« Reply #3 on: June 11, 2017, 07:01:27 PM »
Gday

There can be different opinions on options. Used correctly they can be a valuable tool but used poorly can be a disaster.

I like the idea of selling covered calls over existing holdings as a way of increasing income after a market surge and somewhat reducing risk.

In my case I have a significant core holding in VAS (Aust index fund) that I treat as part of my financial freedom, not interested in selling under any circumstances. Planning to hold for ~50years and it fund my FIRE.

I often sell out of the money call options, generally 5% out of the money 3-6month durations. Typically the premium is ~1% of the covered value, obviously lower than at the money options. I tend to sell these calls after the market has had a good run (+10% in a relatively short period, never after a decline). I have looked at monthly MSCI price levels and run a bunch of tests and my results show ~65% of the time these expire worthless, ~20% of the time it makes sense to roll up and you get some times when the market just keeps on screaming ahead, but of course you are covered after all so worst case is you give away a little upside in the short term after the market runs to hit the strike.

I have generated 1-3% additional returns using this method over the last 5 years or so. It might not be super exciting, although I get some strange satisfaction watching the time value of the options erode.

Good luck and with options I suggest you define what you are trying to achieve, read heaps, build your own pricing calculator from something like Black-Scholes so you can understand the volatility aspect and start small.

Cheers

acanthurus

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Re: Selling call options on QQQ to diversify
« Reply #4 on: June 11, 2017, 09:35:52 PM »
If you'd owe 40% cap gains, I wouldn't do anything that would expose you to that tax liability. I hate paying 15% cap gains, 40% would be horrific with the tax drag.

Can you add things to your portfolio, possibly in tax advantaged accounts, other than VTI that would bring your overall sector exposure of the entire equity portfolio closer to a total market allocation? QQQ is massively underweight basic materials and industrials for instance, and there are cheap ETFs for that. If you can buy those in an IRA it could offset your overweight tech and health care exposure from QQQ.

Just an idea.

acanthurus

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Re: Selling call options on QQQ to diversify
« Reply #5 on: June 12, 2017, 03:18:50 PM »
Yeah those tax rates are... ugh. Congrats on the income to get there though! :) I'm essentially FIRE'd on 1.2M in a LCOL, single with no spouse or kids and living on 20k/year. Short of re-starting an engineering consulting biz I doubt I'll have much income the next year or two. I realize the amount of income required to minimize taxes. Basically I'm at the opposite end of your income/tax situation. Last year I had to realize 65k which kind of sucked, but this year I'll be dead on 37k with zero tax liability.

Your question really is good though, as I went looking but couldn't find any sort of QQQ completion index, such as exists for the SP500 (e.g. VEXAX at Vanguard). I imagine the demand for such a product would likely be smaller than for the S&P completion index, but since QQQ is more or less market cap weighted among the stocks it owns it shouldn't be too hard to construct one for it. I got pretty close portfolio backtesting a mix of QQQ, VFH, VIS, and VAW. Maybe I should try and start an ETF for such a completion index, I hear you only need to swing a few tens of millions in AUM for it to take hold :)

Also if you pursue the options strategy, I thought you might be interested in the performance of the SP500 Buy Write ETF and the SP500 Put Write ETF. The first buys the SP500 index and writes monthly call options against it; the second sells cash secured monthly puts on the index. They both are essentially long the market (so definite downside risk) with capped upside (b/c of the options) supplemented by the premiums they collect (relatively steady income stream). A graph of the two wonderfully shows the idea of put/call parity in action (see attached, PBP and PUTW total return graphed against SP500 total return) since they track beautifully, as well as the relatively constant rate of return and reduction in volatility this strategy can net you.

It's not the NASDAQ but it should help give you an idea of how your idea would work in practice. It does limit the downside exposure somewhat because of the premiums collected, while capping the upside; the near constant walk upward is from premium collection and being long the portion of the portfolio that didn't get exercised away. Just realize that the positive deviation of the index return represents sales of long term appreciated securities that you'd get a tax hit on.

With QQQ being more volatile, you'd probably net a lot more premium but also be exposed to more tax liability as your calls got exercised. I don't have historical options data to model it though. It's certainly an interesting strategy to mitigate risk, and if it weren't for the taxes involved I'd be more in favor of it. The only thing I would modify about your idea would be to sell the call contracts 30-45 days out to maximize your return from theta decay and minimize your call risk. Selling longer dated contracts will net you more net credit up front, but a better idea would be to maximize theta decay of the options contract and that seems to happen somewhere in the 30-45 day range since theta decay accelerates the closer you get to expiration.

Anyway, sorry for the long rambling post, but thank you for asking an interesting question. I hope the additional info I've written today is useful, and please feel free to point out anything you think I might have gotten wrong.

PS: If you really want to minimize downside risk, you might look into collar strategies. They won't net you much if any premium, more likely they would cost just a little bit, but would be a relatively cheap way to finance downside protection on your QQQ portion of your portfolio until you are able to unload it in early retirement. Just be wary if IRS constructive sales rules and be sure to keep your strike prices far enough apart not to run afoul of them. If you did this I'd absolutely use the longest dated LEAPS available and roll them out at the earliest possible opportunity.

Cheers!

« Last Edit: June 12, 2017, 03:23:50 PM by acanthurus »

Financial.Velociraptor

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Re: Selling call options on QQQ to diversify
« Reply #6 on: June 21, 2017, 08:11:46 PM »
Thanks for the great replies.  I've been chewing on this the last week and decided to go for it.  I haven't completely decided on expiration or how far out of the money I'll sell the calls at.  There's just so many options it's hard to decide.  Based on comments here, I'm not going to go too far out on expiration.

One more question - is there a method I can write calls and guarantee I won't get called?  I've never been called before.  I'm concerned if the stock goes up, I could get called without notice and my stock will automatically be sold, realizing all my gains.  If the option goes in the money, I want to be able to close it out without getting called.

I read about one method where I could anticipate getting called and buy more shares and deliver those.  Not sure why I'd do that instead of just closing the option though.

Unless you are very close to expiration and time value is "low" it is unlikely you will be called away early.  Reason is, so long as the time value on the option is "material", it makes more sense to sell the option than exercise it early.  An important exception is if the ex-div date on dividends comes up.  If the distribution is more than time value, it makes sense to exercise early.   While it does happen, early exercise usually requires an irrational counterparty.