Trade: AIG covered call

September 30th, 2009 · 4 Comments

Continuing from yesterday’s post, I’m now discussing the second trade completed this past Friday, part of three trades I’ve done for the October expiration period.   In this case, I’d discovered that the premiums on AIG were huge, and that meant getting a decent profit while still being cautious.  But was I too cautious?

High volatility: pretty much like a roll of the dice?

High volatility: pretty much like a roll of the dice?

At the time of my research, AIG was trading at about $43.60 and the at-the-money call bids were over $5.  That is over a 10% instant return (or 400% APY), but remember these premiums are so high because there’s alot of volatility on AIG.   That volatility is much, much higher than anything else I’ve looked at in my covered call experiences.  For example, during the last 30 days AIG has been as low $34 and as high as $54, and that’s a wide range indeed.  A $4 premium would only prevent losses down to the mid $39s, which isn’t exactly outside the trading range, so it still seems pretty risky to me.  Is the reward worth the risk?

At this point, I kept researching because I had a goal for this period which was to expand my experiences with options and covered calls.   On the one hand, this trade would be done within my GI portfolio which is kind of “side” money.  I’m not yet relying on it for retirement or anything else critical to my family’s well being.  Yes, I’d not be thrilled to lose money, but I want to force myself to learn and I’ve already discovered I do that best when I’m watching a position I’m involved in.

However, I still wasn’t comfortable with the amount of risk involved with an at-the-money position.  So in playing around with different strikes in my spreadsheet, I realized that there were still decent returns to be made even when entering with pretty low strikes.  In effect, I’m trading upside for more downside protection.   After talking over a number of scenarios with my wife, we decided that a trade with a 100% APY and protection down to $35 had an acceptable risk/reward ratio.  That’s a 100% return on our capital where we won’t lose money unless the underlying drops by more than 20%.

Here are the details of the trade actually made.  As usual, I’m including my actual commissions which is why some values go out to fractions of a cent.

Critical Dates:
2009.09.25: Initial position: BTO 100 AIG @ $43.7095
2009.09.25: Initial call option: STO 1 IKG JK (Oct09 $37) @ $8.7037

Summary, if NOT called (static return):
Days position held: 22
Capital investment: $4370.95
Income received: $870.37
Percent return: 19.91%
Annualized yield: 1934.41%

Summary, if CALLED at expiration:
Days position held: 22
Capital investment: $4370.95
Net profit if called: $194.47
Percent return if called: 4.45%
Annualized yield if called: 105.90%

By the way, TradeKing’s probability prediction tool pegged the chance that AIG is above our $37 stike price at expiration as just over 90%.  Unfortunately, I’m not sure how they’re doing that calculation.  Is it historic volatility?  Implied volatility from market inputs?  Some combination of the two?  I’ll need to try to figure this out.  If anyone knows, please don’t hesitate to comment.

While I’ve done this trade at $37, a part of me really feels like I should have been more aggressive.  There is currently a clear upward trend on AIG since early August.  And a bet on that continuing could earn some significant returns.  For example, a covered call using a $49 strike could have earned $821 if it got assigned.  That’s a 1,620% APY!   Even moving the strike up just a few dollars to $39 would have returned an annualized 200% plus.

Am I thinking about the possibilities with AIG correctly?  What would you have done in a similar situation?  Please let me know what you think.

Tags: Options · Trades

4 responses so far ↓

  1. 1 davmp // 2009.10.05 at 12:24 pm

    I’ve been watching my covered call fairly closely, and reading alot more about AIG in the process. At one point last week, I noticed that AIG had dropped below my strike at a rate equivalent to what I picture a stone sinking into a lake to be like, but then it also recovered fairly quickly too. The speed at which AIG fluctuates is pretty amazing / amusing. But not surprising given their business situation.

    Having done a bit more reading over the weekend, I’m wondering how I would have done if I had made a collar play instead of a covered call. A collar is simply adding the purchase of an OTM put (i.e. strike below the underlying’s trading price) to a covered call. I don’t have the option quotes from the time of my original covered call trade, but using current data, I might have BTO AIG @ 42.44, STO IKG JQ (Oct $43) for $3.22, and BTO IKG VU (Oct $42) for $3.35. That would expose me to a max loss of of $65 plus commissions, or a max gain of $35 minus commissions. Not a great profit potential on that combo, and I’d say fairly high risk of losing the max too, but perhaps there are ways to play it a little better given more research into collars? I need to modify my spreadsheets to account for adding the put so that I can play with numbers and get a better understanding of collars.

    That being said, today I was thinking that if I could lock in most of my gains and get out early, I could be pretty happy with that. So I entered a day order to sell out of the covered call for a net credit of $36.87. That would net me just over 90% of the profit expected if my covered call was assigned at expiration. As a point of reference, the current net credit mid-point quote is $35.56, which would get me just over 20% of the original profit. So there’s still quite a gap between my order and the current market ($1.21) however, I’ve seen this move more than $1 in a day last week, so perhaps I could get lucky and hit. If not, I’ll take another look tomorrow morning.

  2. 2 davmp // 2009.10.06 at 8:28 am

    My close out for a net credit of $36.87 didn’t trigger yesterday, but the current quote for it has a $36.12 mid-point. I’ll re-enter my order for a $36.87 net credit and see if it triggers today. AIG is currently up and trading at ~$45.25.

  3. 3 davmp // 2009.10.12 at 10:54 am

    Well, the net credit I mentioned in the last comment also didn’t hit for the day order I had entered. But after watching the prices fluctuate for a bit, I then figure that the likelihood of AIG ending up below my $37 strike was pretty small, so instead I decided to enter a GTC order for a net credit of $37.06. Given the trading commissions at TradeKing will be $5.60 more than at expiration, this will allow me to capture the maximum profit I had in mind when entering the position. That is, it’s equivalent to being above $37 at expiration. As of just a few moments ago, AIG and IKG JK had an net credit ask just pennies from this $37.06. It’s possible I’ll sell out of my position today. (BTW: AIG is at 44.12 as I write this.)

    I could aim to hold on to things an wait for a better net credit, but I’m still a bit nervous about the volatility for AIG,. So I figure capturing my max profit and being out earlier is wonderful!

  4. 4 davmp // 2009.10.18 at 11:44 pm

    Duh! No one in their right mind would ever sell at a net credit of $37.06 as that’s higher than the positions should ever be worth. Once the call is in the money, it should be pretty close to 100 delta, and thus track every market movement pretty closely. Indeed, my $37.06 was never hit and the option ended up being assigned at expiration. I could have easily sold it for a lower net credit, say around $36.95, a couple times. In the future, I’ll be entering such orders as soon as I enter a position. Thus ensuring I get out as soon as I can with most of the target profit, which will lower the risk of holding through a large drop simply because I was waiting until expiration to capture that last $10.

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