Looking to sell the calls for your collar? Maybe look to September

by Wayne Ferbert on July 24th, 2012

In yesterday’s post, we discussed the issues with selling OTM calls on a down day in the market. The mid-day mini-rally yesterday did not carry over in to today. So, the same problem persists today.

But maybe the market is giving us some room to operate. Normally, I wouldn’t recommend going out an extra month on the time curve to sell the call. But there are exceptions. Right now, on many of the largest ETFs that we use for our portfolio allocations, the September expirations have MATERIALLY more time value than the August expirations.

This would normally be explained by time. The September expiration has a whole extra month so of course it has more premium in its price. But in this case, the extra premium seems skewed. There are 59 days until expiration for September and 24 days until the August expiration. This is almost 2.5x the time in days. However, take a look at any strike that is OTM for puts on the MDY, IWM, SPY, or EEM. The premium in the call value is usually 3-4x for the September call than it is for the August call.

So, instead of pocketing that extra premium by moving to the September calls, we recommend that you move your strike a little further back as you move to the September calls. Remember that we look to collect premium for the calls to just pay for the put protection AFTER we adjust for dividends collected AND AFTER we are willing to accept about a 1% cost to hedge.

So, don’t pocket the extra premium by moving to the same strike in September that you would have used in August. Instead, look to move to a higher strike in September. Give your portfolio more room to run!

But understand the change in risk profile you are making. You will be able to set a higher strike price which is great – but you have 2.5 times the amount of time for the market to make a run up – and possibly thru – your strike price for September. In other words, you are increasing your time risk. This is why that premium exists. But the skew right now looks attractive – so it is worth considering.

Good luck selling your calls – this has been a terrible start to the new option month!


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