Wiki Selling TSLA Options - Be the House

[MP3Mike]

As I understand it, if the price goes below a certain level (say $500) the brokerage will begin liquidating your shares to cover the margin loan and they won't let it get to a point where you are liable for more than you borrowed

Don't assume that they would set up a "stop loss" order for you. It could drop to $200 before they get to liquidating your assets. But unless you invest in options, or short the stock, you can't end up owing more than you borrowed, plus interest.

But many people end up losing more than they borrowed.

 

[mongo]

I agree, and as I understand it, that is why they would forcibly sell the shares if the price hits a certain level, and continue to do so as needed in order to protect their position. I did have a long talk with TDA and they assured me that my strategy was sound, but I wanted to review it with other traders as well.

If the shares used to create the covered call are liquidated, then the liability on the call becomes unbounded (if stock rises in the future). Closing the calls will require additional cash. So the margin requirements may be higher than you are expecting.

 

[Yoona]

2 wins this week. 13 straight!

Sold Iron Condor +p660/-p675/-c730/+c740
- Although the closing SP 672.37 was outside the 675-730 range, it was above the 670.04 breakeven point.
- Profit=$21k instead of $49k due to the -p assignment
- The lesson for me here is: BE PATIENT. Build the IC on Wednesdays, as my usual routine. But i built this early Monday and didn't get the chance to see the SP downward "trend" on Mon/Tue; therefore, it was ITM the whole week. Range was in danger right from the start.

Sold May 14 CC 750
- Rolled to May 7, and roll roll roll until close to the strike on Friday.

 

[Xepa777]

I just sold several $60 - $100 CC at $700 strike for a total of $400 gain today. Peanuts, but for a first generation college student it's sufficient for me on a one day expiry

 

[Flehmenlips]

If the shares used to create the covered call are liquidated, then the liability on the call becomes unbounded (if stock rises in the future). Closing the calls will require additional cash. So the margin requirements may be higher than you are expecting.

Understood. As explained to me by TDA, they would manage this by simultaneously executing a buy to close order on the covered call coupled with a sale of the underlying equity. What impact this has on my current margin maintenance requirement is not clear.

 

[Flehmenlips]

Don't assume that they would set up a "stop loss" order for you. It could drop to $200 before they get to liquidating your assets.

Good to know. It seems it would be prudent to set my own "stop loss" order.

But unless you invest in options, or short the stock, you can't end up owing more than you borrowed, plus interest.

I want to know what this means, in the context of my hypothetical scenario. I think I understand it to mean I can't lose more than my original cash investment, BUT, if I essentially trade that initial cash investment for premiums, I can't lose much more than a small fraction of my original cash investment?

But many people end up losing more than they borrowed.

I see the danger here.

 

[samppa]

Sorry for the confusion. I'm going to create a hypothetical scenario to make it more clear:

Let's say I don't own any TSLA stock but have $125K in savings.
I am going to buy a house in two weeks. The down payment needed is $100k. I have the $125k in cash now, but would like to leverage it more effectively. I place it in my brokerage account which has a 40% margin requirement for TSLA. I then leverage the full margin and purchase 400 shares of TSLA at $650 for a total of $260k, using $104k of my cash as leverage. I then sell 4x June 23 covered calls at a 750 strike for a premium of $23,000 per contract, and therefore have $92K in premiums plus my remaining $21k in cash. I withdraw $100k in cash for my downpayment and am left with $13k in cash in my account and still hold 400 shares of TSLA under contract, which if and when called away in two years will give me a return of $40k. If my brokerage is charging say 3% interest on the $156k margin loan, that is a cost of $9360 over two years, and I still net over $30k or $15k per year. If stock price crashes and I get margin called, the shares are liquidated and contracts closed and even if I get liquidated to zero, I have only lost the amount of margin interest paid to date and possibly the $13k that was still in my account. If the stock goes down modestly, and I can source a bit more cash, I can buy the contracts to close and I'm good. Either way, I still have the downpayment for my house and potentially some profit and potentially some $TSLA if I can buy the contracts back. What am I missing here?

Lets look at this from the start first.
You use 104k cash to purchase a total of 260k worth of TSLA. So you're borrowing 156k.

What's your maintenance margin now? The bought shares will provide more collateral, so at this point you're probably not maxing out your margin yet.

What is the price point to get a margin call? Calculate that. How much can tsla tank until you get a margin call? Does your broker do margin calls, eg. IB doesn't, they will automatically liquidate positions.

What happens if your broker raises margin requirements? 40% seems kind of low here, IB has about 65% and looks like they are raising it soon.

When stock is collateral, remember that if broker liquidates, you will also lose that collateral. Of course it becomes cash which works the same, but if tsla tanks to $300, they need to liquidate a lot more shares to have enough collateral to cover that 156k.

 

[Oil4AsphaultOnly]

This doesn't compute. I would not be withdrawing the original cash, only the premiums collected, which should be the equivalent of adding $100k cash to the account and immediately withdrawing it again (as I understand it).

Yes, this is true. If I am super leveraged on margin and the price drops very far, the $13K and the stocks would be at risk. However, it still seems to me that is ALL that is at risk, along with any margin loan interest paid to date.
To add more to this scenario, if I didn't need to take out the cash, I could simply take the $92k in premiums and buy another 100+ shares with it and then have ample collateral to ease the margin position and have a nice block of shares to either hold or sell covered calls. In that case I would be long 400 shares, under contract for a small potential profit at assignment, and long 100+ shares free and clear, accompanied by a $156k margin debt. All from an initial investment of $125. This seems like a plausible scenario to me. Thoughts?

Okay, I think I have the situation worked out.

So let's recap your hypothetical and see if this makes sense:
- you started off with 125k in cash.
- your broker has a 40% margin requirement on TSLA, so you buy 400 shares of TSLA @ $650/shr (104k is your equity, 156k is on margin loan).
- you sold four Jun '23 CC's and collected 92k. If your shares get liquidated, this becomes a naked call position and should be subject to the same 40% margin requirement.

If TSLA drops *below* $617.50 ($32.50 loss per share, ~5%) next week, you will no longer meet your margin requirement (156k is still on margin, but your equity dropped to only 91k and your $13k cash doesn't backfill enough to cover the remainder). Whether or not you get margin called at this point is up to your broker. Also, if any shares get liquidated, then you'll need to supply enough cash to buy back the "now naked call". I've calculated ~41 additional shares will need to be liquidated (along with your $13k cash) to provide the funds to BTC the call option at $22,555. So you'll still hold 358 shares and 3 covered calls.

TSLA around ~570, you'd barely have enough equity left ($72k + $13k cash) to liquidate all your shares and BTC all your call options (an $80 SP drop corresponds with a $20 drop in option value). Below $570 and you'll lose more than your original investment.

But there's one other risk that samppa brought up. If TDA raises the margin requirements (which they've done when volatility goes wild) to 50%, then unless the SP rises to above $747.50/shr, you would still NOT meet your margin requirement (156k is still on margin, leaving you with 143k in equity and your 13k cash). And if any shares get liquidated here, then your call option would cost more than $23k to BTC. To add insult to injury, you will now owe short-term capital gains on your liquidated shares (which would be offset by the short-term loss on the covered call.

If the margin requirement is raised AND the SP is lower than purchase price, then your losses compound. Funny enough, even in that scenario TSLA would need to drop to around $570/shr before your entire investment is wiped out.

 

[dl003]

Maxing out your margin is never a good idea, especially in a volatile stock like TSLA. Furthermore, the sale of the 750 calls only adds to your cash position, not your account balace. That changes the margin requirement dramatically when you withdraw $100k. May I propose a share replacement strategy with DITM LEAP calls? You would buy 5x vertical June 23 400/750 call spreads for a total of $60k. Your potential return would be nearly 200%. If you withdrew 100k, your margin would be only 125-60-100=35k.
Say, in both scenarios, your initial portfilio balance would be 125k - 100k = 25k
I think the first scenario (25k portfolio, 150k margin) wouldnt be possible as a margin call would be instant. On the exp date, your potential account balance would be 750x400 - 150k = 150k tops.
The second scenario (25k portfolio, 35k margin) would be much safer. On the exp date, your portfolio would be 350x500 - 35k = 140k tops. 25-35 would still be very tight but much easier to deal with.
Of course you could do more than 5 spreads if you decided to take that route.

 

[Criscmt]

I'm not sure I understand...it still comes back to the same equation: [Margin Requirement] = [$ value of spread] * [100 shares] * [# of contracts]

Am I missing something in your question?

You are right. The only part of your answer I found to likely not be correct at least with some brokers is the margin needed for IC.
As @setipoo said in one of her replies, the margin needed seems to be sum of risk in play on both sides, rather than the higher of the two.

 

[Criscmt]

typo, sorry!

credit is 49k

49/250 for one week. That's amazing returns. And you call this "top up"?
I am finding it hard to believe your CCs got anywhere near to this amount, unless you sold ATM.
I might be very wrong on CCs. And, I know what CCs get you depend on the number of calls you sell, but I am going by the assumption that the number of CCs is relatable to the 250k margin.

 

[Discoducky]

The wheel has been exceedingly profitable for many of us, but now it is time to do taxes.

I'm assuming that my cost basis for sold calls (where I'm the writer/seller) and puts is $0 when they expire worthless; is that correct? Or is it the amount of money that I paid my financial institution for placing the order? I know it is paltry like $6.50 or sometimes even $0.

Edit: Thanks in advance! I spent an hour on a call with Intuit and none of their supposed tax experts knew the answer.

Edit: Found the answer is that commission and fees are just deducted from taxable earnings so cost basis of $0 seems to be correct.

I have another issue now though as my 1099-B shows, for these calls/puts that I wrote/sold that expired worthless, is the date sold equal to the date acquired? That is what it shows on all my accounts so I guess that is right, but it just seems weird as these were "sold" into the market weeks or months prior to them expiring worthless.

 

[juanmedina]

49/250 for one week. That's amazing returns. And you call this "top up"?
I am finding it hard to believe your CCs got anywhere near to this amount, unless you sold ATM.
I might be very wrong on CCs. And, I know what CCs get you depend on the number of calls you sell, but I am going by the assumption that the number of CCs is relatable to the 250k margin.

Credit spreads and IC are great until you screw up. At least with naked puts and covered calls you have something to show for if you are wrong. I do credit put spread a lot but I am usually way OTM for instance for last week I had -610/+590s and it was still more profitable than a straight naked put with IIRC a third/fourth of the cash required vs a similar strike put. The problem is that if the SP goes past the long leg you are done. @setipoo what is your win rate? do you have spread sheet or something showing the strikes that you picked? Thanks.

 

[Yoona]

@setipoo what is your win rate? do you have spread sheet or something showing the strikes that you picked? Thanks.

i think my IC is 4/6 or 5/7? I don't use spreadsheet since I am a dummy with manual data entry. I wrote automated scripts that send bank data directly into my customized trading reports:

Here is a strike/income page from last week:

 

[Flehmenlips]

Maxing out your margin is never a good idea, especially in a volatile stock like TSLA. Furthermore, the sale of the 750 calls only adds to your cash position, not your account balace. That changes the margin requirement dramatically when you withdraw $100k. May I propose a share replacement strategy with DITM LEAP calls? You would buy 5x vertical June 23 400/750 call spreads for a total of $60k. Your potential return would be nearly 200%. If you withdrew 100k, your margin would be only 125-60-100=35k.
Say, in both scenarios, your initial portfilio balance would be 125k - 100k = 25k
I think the first scenario (25k portfolio, 150k margin) wouldnt be possible as a margin call would be instant. On the exp date, your potential account balance would be 750x400 - 150k = 150k tops.
The second scenario (25k portfolio, 35k margin) would be much safer. On the exp date, your portfolio would be 350x500 - 35k = 140k tops. 25-35 would still be very tight but much easier to deal with.
Of course you could do more than 5 spreads if you decided to take that route.

You just broke my brain. I need to dig into this. More clarification would be appreciated.

 

[Yoona]

You just broke my brain. I need to dig into this. More clarification would be appreciated.

i am also trying to understand it, but can't... 200% return !

 

[dl003]

You just broke my brain. I need to dig into this. More clarification would be appreciated.

So the math goes like this (rounded to the nearest $5k):
Proposal:
$125k initial portfolio balance, including: $260k TSLA - $135k margin
Shorting 4x June 2023 750 calls which adds $100k cash, your portfolio becomes: $260k TSLA - $35k margin - $100k short calls = $125k still.
Withdrawing $100k for down payment on a house: $260k TSLA - $135k margin - $100k short calls = $25k
What you didn't account for was the $100k you get from selling the 750 calls wouldn't add to your portfolio balance immediately because their time value would still be $100k.
It'd be technically impossible for you to withdraw $100k cash even after you have sold the calls. You can't borrow $135k while your account only shows $25k, unless your last name is Hwang.

Now, if you buy 5x 400/750 spread, each costing $12k instead:
$125k initial portfolio balance, including: $65k cash + $60k in spreads
Withdrawing $100k, it becomes: -$35k margin + $60k in spreads = $25k balance
If you calculate your return by dividing the potential value in June 2023 with both legs ITM by the premium, you'll end up with $175k/$60k - 100% = 191.67%
If you calculate your return by dividing the final account balance by the initial portfolio balance, you'll end up with $(175k - 35k)/25k - 100% = 460%. Basically you put down $25k today for a chance to win $115k in 2 years. Now, not many brokers will allow you this much margin to spend on spreads. On shares, sure, but options are deemed much riskier. I think some will, though. What you'll likely end up doing is skipping the whole withdrawing $100k all together and just:
(1) Deposit $25k into your account with the highest option trading level your broker allows (I suggest a TD advanced account)
(2) See how many spreads your broker allows on margin
(3) Get ready to deposit more money to keep the position afloat.

 

[bxr140]

Credit spreads and IC are great until you screw up.

The problem is that if the SP goes past the long leg you are done.

Fundamentally there is no difference between covered, naked, and credit spreads when it comes to getting into a bad place, the probability of recovery, the method of recovery, and the time it takes to recover. The strike of the long leg of a spread is irrelevant; It’s all about where the short leg is since in all cases that’s what defines how bad the place is.

The magnitude of the risk for a credit spread is going to be higher BUT the reward side of a credit spread is higher and often more so than the risk side is worse (which is A Good Thing). Certainly the slope of the badness curve is steeper for the credit spread so it sucks on the way down into that bad place BUT that same steeper slope turns into goodness when clawing your way out, which is why it (again) fundamentally doesn’t matter if the position is covered, naked, or spread.

Management of unfavorable downside comes back to a) selecting sensible strikes and b) following sensible position sizing logic.

 

[juanmedina]

Fundamentally there is no difference between covered, naked, and credit spreads when it comes to getting into a bad place, the probability of recovery, the method of recovery, and the time it takes to recover. The strike of the long leg of a spread is irrelevant; It’s all about where the short leg is since in all cases that’s what defines how bad the place is.

The magnitude of the risk for a credit spread is going to be higher BUT the reward side of a credit spread is higher and often more so than the risk side is worse (which is A Good Thing). Certainly the slope of the badness curve is steeper for the credit spread so it sucks on the way down into that bad place BUT that same steeper slope turns into goodness when clawing your way out, which is why it (again) fundamentally doesn’t matter if the position is covered, naked, or spread.

Management of unfavorable downside comes back to a) selecting sensible strikes and b) following sensible position sizing logic.

What I was referring to is that if the SP goes past the long leg there is no saving the spread. Even if you try roll it the position you are max lost and rolling will do nothing; while a naked put and CC I can keep rolling them if they are ITM until I can let the position expire OTM. Also, even if let the naked put expire or CC I will end up with something. I had a spread that went bad all the sudden and that's how it behaved IIRC, Am I mistaken on that's how it works? I got lucky that time because the stock decided to move favorably and I was able to save the spread. Thanks

 

[Flehmenlips]

So the math goes like this (rounded to the nearest $5k):
Proposal:
$125k initial portfolio balance, including: $260k TSLA - $135k margin
Shorting 4x June 2023 750 calls which adds $100k cash, your portfolio becomes: $260k TSLA - $35k margin - $100k short calls = $125k still.
Withdrawing $100k for down payment on a house: $260k TSLA - $135k margin - $100k short calls = $25k
What you didn't account for was the $100k you get from selling the 750 calls wouldn't add to your portfolio balance immediately because their time value would still be $100k.

I don't understand this part. I thought that when you sell covered calls, the premium is a cash payment to your account that is available immediately and is available to use and spend however one chooses. Is this different with long dated covered calls?