Comparing Covered Call Writing & Cash-Secured Puts in Bull Market Environments – August 21, 2023
Covered call writing versus cash-secured puts in bull markets … which is better? This article will present the arguments for both and make a case why I prefer covered call writing in favorable, uptrending market conditions.
The case for cash-secured puts (CSP)
CSPs generate an initial premium return plus allow us to roll-up deep out-of-the-money (OTM) puts when share price appreciates significantly. This permits us to generate additional time-value premium over-and-above the original premium. See chapter 25 in my book, Exit Strategies for Covered Call Writing and Selling Cash-Secured Puts for a real-life example with INMD.
The case for covered call writing (CCW)
In bull markets, we sell OTM calls which allow for initial time-value premium plus the opportunity to take advantage of share appreciation from current market value up to, but not beyond, the OTM strikes. If share price rises exponentially, we can implement the mid-contract unwind (MCU) exit strategy which creates the opportunity to generate greater than a maximum return with the same or similar cash investment and a new underlying security. See chapter 7 in my book, Exit Strategies for Covered Call Writing and Selling Cash-Secured Puts for a real-life example with NUE.
Delta is the common denominator
When comparing the 2 strategies, we must keep in mind that stocks and ETFs have Deltas of 1. Option Deltas are lower. If share price accelerates by $1.00, our portfolios will benefit by $1.00 for each share owned with covered call writing, up to the OTM strike price. If share price accelerates by $1.00, put premiums will decline by its Delta value, let’s say $0.40 for an OTM put strike, as an example. This allows us to buy back the original put strike and roll-up to a higher strike, for a net credit. Will that credit equate to $1.00 per-share? Unlikely.
Real-life example with Intel Corp. (Nasdaq: INTC): 2/13/2023 – 3/17/2023
INTC trading at $27.90
Note the following:
- The initial time-value premium is greater for the $27.50 OTM put ($1.00) than for the OTM $30.00 call ($0.42) because the call is deeper OTM
- With INTC trading at $27.90, there is opportunity to benefit by $2.10 per-share using the $30.00 strike (total potential return = $0.42 + $2.10 = $2.52)
- Put initial return is $1.00. Can we generate an additional $1.52 by rolling-up put options? Unlikely
Hypothetical scenario where INTC increases in value to $29.40 by expiration
- Total covered call unrealized (shares not yet sold) return = $0.42 + $1.50 = $1.92
- The cost-to-close the $27.50 put will be < $1.00, perhaps $0.60 (deducting $0.40 from the original premium, assigning a Delta of -0.4 for the put)
- Rolling-up will result in a net credit, but not close to $0.92, the amount we would need to match the covered call trade
- Another factor against the put case, is that Theta (time-value erosion) is working against us as we try to compensate for the share appreciation on the call side with premium credits on the put side
What if INTC moves up dramatically allowing us to roll-up our puts multiple times?
This is great news for the put-seller as we can implement our rolling-up strategy several times to generate multiple time-value credits. However, we have our MCU opportunity on the call side, so I would consider this scenario a wash.
Discussion
If our outlook for the market is bullish, both covered call writing and selling cash-secured puts with rolling-up opportunities can both represent successful trades. However, covered call writing OTM strikes will present the greatest upside in these conditions.
Author: Alan Ellman