6 Months Of Covered Calls & CSPs: Small OTM Bets

Hey guys! Let's dive into a strategy I've been running for the past six months – a combo of covered calls and cash-secured puts (CSPs), all focused on making small out-of-the-money (OTM) bets. It's been a pretty interesting journey, and I want to break down what I've learned, what's worked, and what hasn't. This isn't financial advice, obviously, and everyone's situation is different, so always do your own research before making any decisions. This is an exploration of my personal experience, and the goal is to show you how I approach this. This will include how I select stocks, manage risk, and adjust my strategy based on market conditions. It’s all about generating income while aiming to mitigate risk. I'll also walk you through the nitty-gritty of choosing strike prices, managing assignments, and rolling options. I’ve focused on small OTM bets, which generally means I’m selecting strike prices slightly above or below the current market price of the underlying stock. This helps to provide a cushion in case the stock price moves unfavorably. My primary goal here is to earn a consistent income stream. Let's see if the covered call and CSP strategy is suitable for you.

Covered Calls and CSPs: The Basics

So, what are covered calls and CSPs? For those new to options, here’s a quick rundown. A covered call involves owning shares of a stock and then selling a call option on those shares. You’re essentially agreeing to sell your shares at a specific price (the strike price) before a specific date (the expiration date). In return, you receive a premium – the money someone pays you upfront for the option. The premium is the profit!

On the other hand, a CSP involves selling a put option on a stock you don't own. You’re agreeing to buy the stock at a specific price (the strike price) if the option is assigned. Again, you receive a premium for this. If the stock price stays above the strike price at expiration, you keep the premium and the option expires worthless. If the stock drops below the strike price, you're obligated to buy the stock at the strike price. This position then becomes a covered call strategy. The covered call generates income from the premium received, while the CSP generates income from the premium received, and it can also acquire shares at a price you are comfortable with. The beauty of these strategies is they are relatively straightforward to understand, and they offer a way to generate income in different market conditions. This is how I’ve been using them – to generate income and manage my portfolio.

Stock Selection: Finding the Right Candidates

Choosing the right stocks is crucial. I've focused on companies I understand and believe in for the long term. This gives me a higher level of confidence when I'm selling options against them. Before I sell any options, I research the company's financials, its industry, and the general market sentiment. This helps me to assess the potential risk and reward. Some of the criteria I look at include the company’s financial health, including debt levels and profitability, as well as the volatility of the stock. High volatility can mean higher premiums, but it also increases the risk of assignment or the stock price moving against you. Then there's the sector the company operates in. I try to diversify across different sectors to reduce my overall portfolio risk. I aim for companies that have solid fundamentals and a history of stable performance, or those that have the potential for strong growth. This selection process is what I'm aiming for.

Once I've identified potential candidates, I evaluate their options liquidity. Liquid options are easier to trade and allow you to quickly adjust your positions if needed. I check the bid-ask spreads and the open interest on the options chain to gauge liquidity. Narrow bid-ask spreads mean the difference between the price buyers are willing to pay and the price sellers are willing to accept is small, indicating high liquidity. Open interest tells you how many contracts are currently open, and higher open interest suggests more market participation and, therefore, better liquidity. Always remember, the better the liquidity, the easier it is to get in and out of the options. Finally, I monitor for news and events that could affect the stock price. This might include earnings announcements, product launches, or any other major developments. Knowing what's on the horizon allows me to anticipate potential price movements and adjust my strategy accordingly.

Setting Strike Prices: Small OTM Bets

I typically aim for small OTM strike prices. This means the strike price I choose for my covered calls is slightly above the current market price, and the strike price for my CSPs is slightly below the current market price. The goal is to collect premiums while minimizing the chance of assignment (for covered calls) or being assigned shares (for CSPs). The further OTM you go, the lower the premium, but the lower the risk. The closer you go, the higher the premium, but the higher the risk. The balance lies in finding a strike price that offers a decent premium without taking on too much risk. This balance is something you get better at over time as you understand market dynamics and your own risk tolerance. When selling covered calls, I choose a strike price that's far enough above the current stock price to give the stock some room to move up without triggering assignment. For example, if a stock is trading at $50, I might sell a call with a $52.50 or $55 strike price. This way, if the stock goes up, I still profit, but I cap my potential upside.

With CSPs, I select a strike price slightly below the current price, again aiming to collect a premium. I have to be okay with buying the stock at the strike price if the option is assigned. This means I want a price I’m comfortable paying. If the stock drops, and I'm assigned the shares, I'm okay with owning the stock. If the stock stays above my strike price, the option expires worthless, and I keep the premium. It's a win-win situation. The specific OTM distance varies depending on the stock's volatility and my risk appetite. I also consider the time to expiration. Options expiring further out offer more premium, but they also carry more risk. It's a trade-off. Choosing the right strike price is key to managing risk and maximizing income. The small OTM strategy is a conservative approach, but it can still generate a steady income stream over time.

Managing Risk: Protecting Your Portfolio

Risk management is paramount. I'm always looking for ways to protect my portfolio and minimize potential losses. One of the first things I do is to diversify my holdings. This means not putting all my eggs in one basket. I spread my options across different stocks in different sectors to reduce concentration risk. If one stock takes a hit, it doesn't devastate my entire portfolio. I also keep a close eye on the market. Market conditions can change rapidly, and I adjust my strategy accordingly. In a rising market, I might be more aggressive with my covered calls, perhaps choosing strike prices that are closer to the current price. In a falling market, I might be more cautious, selling CSPs at lower strike prices to ensure I'm comfortable owning the shares.

I always know my maximum risk before entering a trade. For covered calls, my maximum loss is the difference between the purchase price of the stock and the strike price, minus the premium received. For CSPs, my maximum loss is the strike price multiplied by the number of shares. Knowing your maximum loss allows you to make informed decisions about how much risk you're willing to take. I also use stop-loss orders on my underlying stock holdings. A stop-loss order automatically sells your shares if the price drops to a certain level, limiting your potential losses. Although, this could change. Lastly, I pay close attention to the Greeks, especially delta and theta. Delta tells me how much the option price is expected to change for every $1 move in the underlying stock. Theta measures how much the option price decays each day as it gets closer to expiration. Monitoring these helps me understand my risk exposure. The biggest thing is understanding the underlying asset and making sure you are comfortable with its performance.

Adjusting and Rolling Options

Sometimes, things don't go as planned. That's when adjusting and rolling options comes into play. If a stock price moves against me, I have several options. For covered calls, if the stock price goes above my strike price, I might consider rolling the option up and out. This means buying back the existing call option and simultaneously selling a new call option with a higher strike price and a later expiration date. This allows me to potentially capture more profit. The premium I receive from selling the new call will help offset the cost of buying back the old one. If the stock price is just slightly above the strike price, I might let it get assigned and then look for new opportunities to sell covered calls on the stock.

With CSPs, if the stock price falls below my strike price, I have to make a decision. If I'm comfortable owning the stock at the strike price, I let the option be assigned. I then own the shares and can start selling covered calls. If I'm not comfortable owning the stock, I can roll the option down and out. This involves buying back the existing put option and selling a new put option with a lower strike price and a later expiration date. This gives the stock more time to recover and potentially avoids assignment. The roll can be done for a net credit or debit, depending on the market conditions and the new strike price and expiration date.

Rolling options is a dynamic process. It requires constant monitoring and quick decision-making. You must understand how to adjust your position to your advantage. The goal is to adapt your strategy to the current market conditions. It’s also important to remember that every roll incurs a cost, which is offset by the premium received from selling the new option. The best thing is to look at all possible scenarios and plan accordingly. Sometimes, you'll close out your position early if it makes financial sense. You might take a small loss to avoid a larger one down the road. It's all about making smart, informed decisions to protect your portfolio.

Performance Review: What I've Seen

Over the past six months, I've seen both ups and downs. The market has been volatile, and different stocks have performed in different ways. Overall, the covered call and CSP strategy has generated a steady income stream. I’ve been able to collect premiums on a regular basis, which has helped offset the potential for losses. The strategy has performed well in sideways or slightly upward-trending markets. However, the income generated is usually less than holding the stock outright. The key is in the consistent stream of income, rather than trying to hit a home run. I've also had to manage a few assignments, both on covered calls and CSPs. When a covered call is assigned, it means I have to sell the underlying shares. Then I look for new opportunities to sell covered calls on other stocks. When a CSP is assigned, I have to buy the shares at the strike price, which I'm comfortable with. This converts my strategy to a covered call strategy.

The biggest challenge has been navigating the market volatility. High volatility can lead to large price swings, which can put pressure on my positions. This is where active management and adjustments are crucial. Despite the challenges, the covered call and CSP strategy has been effective in helping me achieve my financial goals. Although, it is a very time-consuming process and you have to be very active and follow the market. The success really depends on the stocks you choose and the market conditions. It's a strategy that requires patience, discipline, and a willingness to learn and adapt.

Tips and Tricks: Learn From My Experience

Here are a few tips and tricks based on my experience:

• Do your research: Thoroughly research any stock before selling options against it.
• Start small: Don't go all-in right away. Start with a small amount of capital and gradually increase your positions.
• Diversify: Spread your options across different stocks and sectors.
• Monitor your positions: Keep a close eye on your positions and make adjustments as needed.
• Understand the Greeks: Learn about delta, theta, and other Greeks to understand your risk exposure.
• Have a plan: Always have a plan for what you'll do if the stock price moves against you.
• Be patient: Options trading can be slow, but it can be a rewarding way to generate income.

Conclusion: Is This Strategy For You?

So, is this covered call and CSP strategy right for you? It depends. If you're looking for a way to generate income, have a long-term view, and are comfortable with the risks of options trading, it's definitely worth considering. It can be a great way to generate consistent income, especially in sideways or slightly upward-trending markets. However, it requires active management and a willingness to learn. You have to be comfortable with the possibility of assignment and understand how to manage your positions. If you are not familiar with options, you should learn about options. If you're new to options trading, I suggest starting with a small amount of capital and practicing with a paper trading account to get a feel for the market. Overall, this strategy has been effective for me. I hope my experience gives you a better perspective on if this could work for you too! Good luck!