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Call spread strategies for high returns and lower risk

Discussion in 'TSLA Investor Discussions' started by mrmage, Jun 14, 2020.

  1. mrmage

    mrmage Supporting Member

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    My core TSLA holdings are in shares and calls purchased awhile ago which I don't trade. However, I want to continue investing in TSLA even at elevated volatility and prices, without incurring too much risk. The high implied volatility has made naked calls too expensive, so calls spreads have been my solution to making high premiums work in my favor.

    Everyone knows that premiums for naked calls are expensive now, which hurts ROI. One way to make high IV work is to write covered calls and naked puts. However, these have lower returns than I like, so I'll compare naked calls to call spreads instead.

    Case 1: Out of the money calls vs call spreads

    For a naked OTM call, I'll use the Jan 2022 1500c that's around $150. Breakeven at expiration is SP $1650. If TSLA goes to $2000, ROI is 230% and $2500 returns 570%.

    Compare that to a Jan 2022 1300/1500c spread which costs about $30. Breakeven at expiration is only $1330 and ROI at $1500 is 560%.

    In other words, the spread at $1500 gives the same return as a naked call at $2500. The advantage of naked calls is no limit on the upside, but essentially you can look at this as a tradeoff - giving up the gains for 500% and higher for a much lower bar of getting 500% returns.

    Case 2: In the money calls vs spreads

    For a naked in the money call, a Jan 2022 700c is $395. Breakeven at expiration is SP $1095. If TLSA hits 1500 at expiration, the profit is 100%. If SP remains at $935 in 1.5 years, the net is -40%. The high option premiums kill anything less than solid gains.

    Compare that to a Jan 2022 700/800c spread for about $50. Breakeven at expiration is SP $750. In other words, if TSLA is 20% *lower* at expiration, this breaks even. If TSLA is *lower* by 15% at expiration($800), ROI is 100%.

    With a call spread, TSLA only needs to be $800 or higher at expiration to net 100%, vs the $1500 for the naked call.

    Other thoughts

    I've been playing with strangles and rotating buy/sells with spreads, and find they suit my style. By no means am I an expert on all things options, but spreads have definitely been growing on me. If you've been doing interesting things with them, I'd love to hear about it.
     
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  2. ⚡️ELECTROMAN⚡️

    ⚡️ELECTROMAN⚡️ Respect the mods stay on topic

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    I'm a total options rookie. Ive never purchased one. Just curious what a good potential long term straddle would be right now. Maybe there isn't one?
     
  3. mrmage

    mrmage Supporting Member

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    I suggested spreads instead of naked options for strangle/straddles, because It’s hard to make a good return with naked options when the time value is high.

    For example, the cost of 450 Jan 2022 call LEAPs is around 35% of TSLA and 370 put is 30% (both 10% OTM). Buying both for a straddle would cost 65% of TSLA. To break even at expiration, TSLA has to be up or down at least 75%!

    Using spreads for strangles / straddles) can return 3:1 for each leg with SP changes of as little as 10%, making the trade likely to be profitable at expiration. My real motivation was selling the bear leg early to break even, then hanging onto the bull leg which I then own for “free”.

    I wouldn’t suggest this kind of strangle for someone new to options though. There are many considerations in finding the right spreads and you need to place a 4 way transaction (2 calls, 2 puts) that balance out the bear and bull legs.

    However, call spreads are worth considering because they’re more conservative than naked calls. Essentially, they’re covered calls on steroids. They have good returns when premiums are high (eg 100% profit if SP is similar to today’s SP or higher at expiration).
     
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  4. Mich

    Mich Member

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    which spread are you referring to?
     
  5. mrmage

    mrmage Supporting Member

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    When call premiums are this high, there are usually many call spreads that are fully ITM with 100% net. However, because the bid-ask can be wide, I look for something in the right time frame and with a premium that's close to what I want, then put a limit order in and see what happens.

    It's hard to do when markets are closed, but for example, @SP around $420, buy 380c/sell 400c for Dec 2020, Jan/Feb/Mar 2021 for under $10, already ITM, and yield $20 for over 100% gain if TSLA is at least $400.

    Or more aggressively, 370c/470c which might cost $35 to $40 and nets up to 150-200%, but still makes 50% if SP stays the same.

    Even though the odds are in my favor, buying spreads on dips makes it even more so. Just be sure to close them out before expiration.
     
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