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Doubling Covered Call Returns with Less Capital

Jul 19, 2024

Doubling Your Covered Call Returns with 75% Less Capital

Introduction

  • Presenter: Seth Freyberg
  • Firm: SMB, prop trading firm
  • Focus: Learn to double covered call returns using only 25% of usual capital

Overview

  1. What are call options and how do they work?
  2. How do covered calls work to extract income from stocks?
  3. How to double returns on covered calls via a specific tweak

Call Options: Basics

  • Call Options: Financial contracts giving buyer the right to purchase a stock at a pre-set price (strike price) before it expires
  • Broker's Role: Allows buying (long) or selling (short) options
  • Covered Calls: Selling call options on stocks you own, earning a premium

Covered Calls

Definition

  • Covered Call: Ownership of 100 shares of a stock + short call at or above current price

Possible Outcomes

  1. Stock price < Strike price: Pocket the premium; retain stock ownership
  2. Stock price > Strike price: Premium retained; shares sold at strike price to call buyer

Example: Covered Call in Practice

  • Scenario: Bought SPY at $395, sold call at $425 expiring in 4 months for $535 premium
  • Outcomes: May 2023 Expiration
    • SPY closes at $418.62: calculate the profit as $2,897
    • Continue strategy for another 4 months
  • Extended to September 2023: sold call at $450 for $3100 premium
    • SPY closes at $443.37: Final trade profit of $5,673 (14.67% return in 9 months)

Problem: High Initial Capital Requirement

  • Barrier: Need close to $440,000
  • Solution: Synthetic covered call

Synthetic Covered Call

Explanation

  • Synthetic Covered Call: Using deep in-the-money (ITM) call options instead of buying stock
  • Example: January 2023
    • Sold SPY call at $425 for $535 premium
    • Bought deep ITM call option: January 2024 $310 for $10,136
    • Initial Cost: Approx. $961 ($1,136 - $535)

Advantages

  • Lower Capital Requirement: 25% of conventional covered call
  • Profit Calculation: May 2023
    • SPY deep ITM call value: $11,849
    • Net profit: $2,535
  • Extended to September 2023:
    • SPY closes at $443.37, call value: $13,826
    • Final profit: $4,526 (32.73% return in 9 months)

Comparison

  • Conventional Covered Call: 22.05% annualized return
  • Synthetic Covered Call: 56.95% annualized return

Conclusion

  • Benefit: Synthetic covered call offers significantly higher returns with lower capital
  • Applicability: Suitable for both professional and retail traders

Further Learning

  • Options strategies to make money while waiting to buy stocks
  • Income strategies for varying market conditions
  • Profit strategies even when wrong on market direction

Full transcript