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October 6, 2005
Low
Volatility - Call-Writing Heaven
by John Brasher, CallWriter Publisher
| There has been a lot of
talk recently about current low levels of market volatility
and what it means for traders and investors, market timers
in particular. I think financial writers are missing the point.
Today's lack of price volatility is a good thing for covered
call writers. Here's why...
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By some measures,
the market is pretty flat and mostly has been for a while now. Volatility
- meaning historical volatility of actual stock market prices -
is at the lowest levels of the past decade. The only surges in volatility
have been due to external (non-market) events such as Hurricane
Katrina, but even these have not been impressive in range and have
not lasted very long. The market has pretty much shrugged them off.
So we have a flat market that, as one writer put it, is like watching
paint dry.
Low market
volatility is pure hell for market timers, those who read the tea
leaves and speculate on price movements through buying puts and
calls or buying stocks. Stock prices just won't cooperate! Why is
volatility low? In simple terms, there is not a lot of interest
in the market. There are not enough buyers to take the market up,
but enough to keep the bears from driving it down. Volatility is
a cyclical thing, and right now it's low.
So if you
are a put or call buyer, life is frustrating. Those
who construct debit spreads (bear put and bull
call), in which a strike is bought close to the money and a further
OTM option is sold, are also watching the market leave them high
and dry. The good thing for market timers (the only good thing)
about a low- volatility market is that it depresses premium, which
is further depressed by low interest rates. This makes options cheaper.
But if long option positions and debit-spread positions are not
working because tired stocks won't move sufficiently, doesn't this
really just mean that the losses are smaller and the stock gains
are smaller?
One writer
recently took the opportunity to knock covered calls and naked puts,
reasoning that with premiums so razor-thin, it makes little sense
to write covered calls or naked puts now. (Remember, a covered call
is just a way of creating a synthetic naked put and has the same
risk/reward profile.) But this logic fails entirely with me, for
several reasons. First, when you have the means to find the highest-returning
covered call trades, as CallWriter does, premiums are not razor
thin. In fact, they can be pretty doggoned hefty. Second, while
premium generally is not what it was 18 months ago, and is far smaller
than during the great bubble market that ended in March 2000, there
still is some fine premium out there. Third, low volatility means
less risk, at least statistically, in writing covered calls, since
there is less risk of the stock dropping during the short window
while the trade is on. Let's see, premium is smaller, but volatility
risk is smaller. Hmmm... sounds like they balance out, doesn't it?
Let's take
a look at some of the covered call plays featured today on CallWriter's
Real Time Lists™ and see if premium is really all that razor
thin. I've culled some interesting trades from our October lists
this afternoon (roughly 2:00 pm ET) to provide some examples. Keep
in mind that October equity options expire on 10/22/05, which means
there are only 16 days until expiration:
| Stock |
Symbol |
Last
Price |
Call
Symbol |
Strike
|
Premium
|
Downside
Protection |
Return
(Flat/Called)
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| Williams
Companies |
WMB |
$23.11 |
WMBJX |
22.50
|
$1.35
|
5.8%
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3.2%/3.2%
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| General
Motors |
GM |
$28.74 |
GMJY |
27.50
|
$2.00
|
6.9%
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2.6%/2.6%
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| Stock |
Symbol |
Last
Price |
Call
Symbol |
Strike
|
Premium
|
Downside
Protection |
Return
(Flat/Called)
|
| Ebay,
Inc. |
EBAY |
$39.94 |
XBAJH |
40
|
$1.65
|
4.1%
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4.1%/4.3%
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| Sandisk
Corp. |
SNDK |
$52.01 |
SWFJJ |
50
|
$4.10
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7.9%
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4.0%/4.0%
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The information
presented above is very abbreviated, and only shows a part of the
data contained in the Real Time Lists™, but you can clearly
see the potential returns. Now these are not goofy little low-volume
stocks that skate all over the place!! These calls expire in 16
days, which is only half a month. So to get the true monthly return,
you double the stated return. Thus a 3.2% return for 16 days really
is over 6% for a month! You are completely
welcome to view it differently, but in my book 6% a month is kicking!
Low volatility
means lower call premiums, yes, yes, yes, but it means lower risk
- at least statistically; you still have to use due care (which
CallWriter teaches) in selecting trades. But don't be misled; there
still is some good premium out there. You just have to be able
to find it. My colleagues and I learned long ago the deep value
in having constantly-updating lists of the highest covered call
returns. That discovery was the genesis of CallWriter. I can only
suppose that the writers mentioned above have no access to our Real
Time Lists™. Maybe you don't either, and if not, I suggest
it's time to give us a try. You might find you like the idea of
clipping coupons in this lousy, mean, boring, old low-volatility
market.
This
issue's Question and Answer:
Use Exponential or Simple Moving Average?
Question:
Which do you prefer for trading, simple or exponential moving averages?
Answer:
I primarily use the 14- and 50-day averages for the short-term horizon.
In my experience, simple or exponential usually doesn't make much
of a difference on this time horizon. Exponents of the exponential
feel that crossovers don't lag as much when using them, but if you
overlay both a simple and EXP 50-day average over a chart there
usually isn't much of a difference. I typically use the simple,
because it is based on raw, unworked data and don't find a marked
advantage with the EXP, but that is just my preference, and no one
will go wrong using the EXP.
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