What is the downside risk of selling covered calls on ETF’s that you dont mind if they get called but also dont mind if they go down in price because you would also be fine with holding them long term? Especially in a Roth IRA with no tax liability. New to Covered calls and looking for some insight.
Downside risk of covered calls with ETF’s in Roth IRA
byu/Hot-Significance338 inoptions
Posted by Hot-Significance338
8 Comments
Your biggest risk is going to be the opportunity cost when the ETF moons past your call strike price. Everyone says they don’t mind getting shares called away, the vast majority actually do though. It’s human nature.
The downside is not the side you need to worry about. It’s the upside.
Try to imagine this scenario as truthfully as you can. You buy 100 XYZ ETF shares for $100/share. The price range for XYZ over the last year is +/- $10, so you write a $115 call for $1 credit, believing you are safe from assignment, but even if you do get assigned, you make a a 16% gain on the assignment, pretty nice!
The Fed cuts interest rates and XYZ’s constituents are big winners, bigger than average, so XYZ appreciates to $140/share. Your shares are called away for $115, so instead of a 40% gain you “only” got a 16% gain.
Can you honestly tell yourself you’d be content with that situation and you wouldn’t regret writing the CC when you could have just held shares without a CC instead?
TL;DR – The absolute **worst** thing you can do in a Roth IRA is cap your upside. The largest tax benefit comes from the largest gains, and those are likely to be *capital gains accumulated over a long period of time*. What a CC does is turn large capital gains accumulated over a long period into smaller capital gains accumulated over a shorter period, wasting the benefit of the Roth.
You’re selling away upside. That is the main risk. You also don’t have the ability to buy back (at a loss) and use those losses to offset gains, which is one of the reasons you might not want to do this in a Roth.
when it goes over you call and you are STUCK you will feel a lot of PAIN because you feel like you lost some $, in reality you did not lose, you just gained less, but its a horrible feeling. Do weeklys and roll as necessary on down days
The primary downside risk with writing CCs is trading away the potential upside. How to minimize this risk? (1) don’t sell a CC. (2) sell CC with small delta, say 0.10 (3) follow trends, fundamentals and technicals to make adaptive decisions about whether or not to sell CC in a given period–if you see a strong upward trend or no clear resistance level, don’t sell a CC. If trend is down or sideways, sell a CC. In general, consistent outsized returns require intelligent decision making. Of course, the number one rule is do not sell CCs except on securities you are very happy to own. Personally, I look at only index ETFs or solid stocks with decent dividends. The main decision for success is which stock/ETF to play with, NOT the prices of options.
Unless you are operating an active overwriting covered call strategy, you may have short term cap gains tax implications for gains on the shares called away. If you are selling calls on shares you would rather keep, buy back the ITM calls at a loss before expiry to avoid short term tax on those shares. hth
The downside the stock drops more than premium collected from cc. Then it drops so much you can’t sell a call at the strike price you bought the shares. Then your just a bag holder until the price recovers. No cc strategy is not the same as buy and hold because a buy and holder offsets his losses with the capital gains. You selling a cc sale you gains for some premuim. You cap your gains but take 99 percent of the losses. It’s losing strategy in the long term.
Downside with CCs regardless of the account type is capping your upside. As long as one is truly ok with losing the shares at the strike price, then there is no real downside.
Plenty of posts out there where that wasn’t the case and folks end up rolling for long swaths of time trying to recover.