Covered Call Play in Focus: UVXY
What's a Covered Call?
The covered call is a strategy where an investor writes a call option contract (sells an option) while at the same time owning an equivalent number of shares of the underlying stock.If this stock is purchased simultaneously with writing the call contract, the strategy is commonly referred to as a buy-write.
While you may have heard that trading options is risky business, covered calls are actually a very conservative strategy, and most brokerages even allow retirement IRA accounts to write covered calls.
ProShares Ultra VIX Short-Term Fut ETF (UVXY)
The ProShares Ultra VIX (UVXY) seeks to replicate, net of expenses, twice the return of the S&P 500 VIX Short-Term Futures index for a single day. The index measures the movements of a combination of VIX futures and is designed to track changes in the expectation for one month in the future. The VIX is a commonly followed measure of the expected volatility of the S&P 500 over the next 30 days. However, since VIX is not directly invest-able, exposure to equity volatility is often obtained though VIX futures.
The UVXY is looking particularly juicy as a covered call play because it's trading at all time lows.
There are risks involved in trading UVXY, These types of investment instruments are fundamentally flawed in our opinion. Leveraged ETFs offer 2X or even 3X the DAILY return of a particular sector or index. We emphasize “daily” because over time, it is a mathematical certainty that unless there is a pure sustained trend in one direction for an infinite period of time (what comes up must come down), the value of your holdings will decrease over time due to leveraged ETF daily re-balancing.
With that said, we don't recommend this as a long-term strategy, but rather more of an intermediate time frame. With the UVXY so low right now, we could see a spike in volatility as the summer continues and the market continues to trade in a choppy fashion.
Our recommendation: The best opportunity right now is to buy underlying shares of UVXY and sell deep out-of-the-money calls. Right now the July 20th $15 Strike, which expires 27 days from the date of this article, are trading at $1.00 a contract right now. That's a pretty nice 10% return for only 27 days. In fact, you could make up your entire investment in the underlying shares in just 10 months doing this, (assuming that you could get the same options premium every month). In this 10 month scenario, shares could go to $1 and you would be even, and any covered calls you sell after that would be profit. However, with this strategy you're bound to run into some high volatility at some point, and the underlying shares could trade up past the strike price of the calls you sold. In this scenario, you'd be up 50% in the underlying stock plus the options premium that you already made selling the calls. It's a win-win strategy. Note that if you wait to sell your covered calls on a day when volatility is up, you will get a better premium.
MASTERY Bottom line:
There are pros and cons to writing covered calls. In theory, this strategy will out perform outright stock ownership if the stock price declines, remains the same, or slightly increases in price. The principal disadvantage of this strategy, on the other hand, is that profit potential can be limited if the underlying stock price advances sharply.
Best of the Blogs
Scanning and identifying the best blog entries every hour
- Market Recap Nov 30, 2015 | FundMyMutualFund
- 2015: The Last Christmas In America | ZeroHedge
- Greek Prime Minister Joins Diplomatic Scandal Between Russia And Turkey With 4 Tweets | ZeroHedge
- Seeking A Savior | ZeroHedge
- ISIS: Oil as a Strategic Weapon | ZeroHedge
- The Lull Before The Storm - An Ideal Chance To Exit The Casino, Part 1 | ZeroHedge
- It's Official: Chinese Buyers Have Left The U.S. Housing Market | ZeroHedge
The most relevant financial news and articles from the Internets
- Group funded by Coke to fight obesity disbanding | Business Insider
- The FIFA stars who voted for Russia and Qatar | Business Insider
- Puerto Rico going down to the wire on $355M debt payment | Business Insider
- The 10 most important things in the world right now | Business Insider
- 10 skills that are hard to learn but pay off forever | Business Insider
- Kevorkian archive opens as physician-assisted deaths rise... | Business Insider
- The Latest: Colorado governor: Man, woman killed in... | Business Insider