There are definite benefits to creating a Covered Call in which we sell Calls against long stock. It’s a strategy that traders can use to lower their cost basis. A Naked Short Call doesn’t seem to fit our usual parameters. Shorting a Call near highs means we are probably selling premium when Implied Volatility (IV) is low since IV usually declines when the market or stock rallies. Shorting Calls near a low will get the benefits of high IV but it means we are selling into weakness. We wanted to see what would happen if we ignored IV and simply took a contrarian approach and sold Calls into strength (after an up move). How would such a strategy perform?
Our study was conducted in the SPY (S&P 500 ETF) using data from 2005 to the present. Every 5 days and using the option expiration cycle closest to 45 days to expiration (DTE) we sold short the 30 Delta Call. We then compared managing winners at 50% of max profit (if possible) or holding to expiration.
A table of the results comparing managing at 50% if possible or holding until expiration was displayed. The table included the average credit, success rate, average P/L and average days in the trade. As expected managing winners outperforms in every metric (except, obviously, for average credit). We then broke down the data into four groups based upon how SPY moved in the week leading up to the entry date. Each group contained 25% of the trades. All four groups were in the trade an average of 20 or 21 days. The group with the lowest average credit received had the best P/L. A final table broke the data down into whether the prior week in SPY was up or down. The average P/L from selling into up moves was dramatically better. Short calls are one of the few strategies in which a lower initial credit resulted in a higher P/L.
Watch this segment of Market Measures with Tom Sosnoff and Tony Battista for the valuable takeaways and the detailed results of our study on selling short 30 Delta SPY Calls into up and down moves in the market and how a contrarian approach would perform.
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