Optimal strike price for long term investing
Hi Mark

I have startied to get my feet wet with options and have made my first few trades in the last month. I am investing
for the long term (my horizon is 20 years).

I used to maintain a buy and hold strategy with index funds until I read your books. Now I beleive it is possible to
increase my returns by 1% a year by selling OTM covered calls. My motivation is strictly long term returns not necessarily downside protection.

I have been trying to figure out what the optimum strike prices at which I should sell covered calls. In reading the CBOE data on BXM (ATM) vs BXY (2% OTM) it seems
the 2% OTM calls outperformed the SPTR by 1%. Now my question is whether monthly calls at  3% OTM, or 4% OTM or 5% or even 10%OTM will yeild better results than 2% OTM?

Have you seen any backtested strategies others than ATM and 2% OTM covered calls on SPY? I would be interested to know where I can get more info on this.

Also, I am noticing that time premiums are much different on ETF's. For example FXI (China ETF) offers much higher premiums that SPY (I am guessing this is driven by the volatility of FXI). This leads me to my second question...

In my search of the "optimal strike price strategy for maximum long term returns" should I be focussed on the optimum % OTM or should I instead be looking for the optimum delta?

Based on my limited understanding of delta, it seems that a 2% OTM SPY has a much lower delta than a 2% OTM FXI. So an optimum delta strategy may be to choose a strike where the delta is at a certain % (for example delta = 20%) regardless of the %OTM of the strike price.

Would love your perspective on this? Thanks in advance for your time.



Hi TR,

You are asking good questions here and I could write a short book supplying a good reply.

1) I have no idea how you could get the data you want comparing OTM % with buy-write returns for the S&P 500.  It would be next to impossible (or very expensive) to collect the necessary option pricing data.  You could write to the CBOE and ask if they have the data you seek, but I cannot imagine they do.

2) Yes, it's the volatility of your China index that makes the premiums (and the risk of owning the ETF) so high.  If that risk concerns you - and apparently it doesn't, you can always write calls that are less OTM.

3) I have not back tested any strategies.  Getting free data may be impossible, unless you can convince the CBOE how important it would be for its customers.

4) Whether you focus on optimum % OTM or optimal delta, they are not going to be very different.  All of the options you are looking to sell have similar delta.  Why?  The more volatile the index, the more likely it is that ANY strike price finishes ITM at expiration and thus, the less difference it makes on which strike price is chosen.  That's why 2% OTM for the much less volatile SPY has a significantly lower delta than the 2% OTM FXI.  It's less likely that SPY moves up 2% before expiration than FXI.  Bottom line: To me, focusing on one is the same as focusing on the other - when you trade a very volatile underlying.

5) Selecting strike prices is not a science.  The more bullish your stance (and you can vary that from month to month), the further OTM options you
tend to sell.  If you lack stock market timing ability (as do most investors), then choosing a consistent strategy makes the most sense.  Ah!  But what should that strategy be.  Not easy to answer.

6) Because you seek long-term growth, and because you are writing covered calls, there must be some compromise.  If the monthly premium is too small, why bother selling options?  In your situation, using FXI options, price is not a consideration.  The option premiums are so high that you need not be concerned with getting 'enough to bother.'  With less volatile ETFs (such as SPY), the premium is much less and it's much more difficult to decide whether to write options that are an extra 1% out of the money.

My point is that this FXI is so volatile, that if you are willing to own it, selling calls with a strike price that is an additional one, two, or three points out of the money is not a huge decision. You will do very will with this ETF as long as it doesn't tank.  If you had not said that downside protection doesn't concern you, I'd suggest writing ITM calls because the premium is 'enough.'  But enough for me is  not necessarily enough for you.

BOTTOM LINE:  If you continue to invest in this volatile ETF and if you are correct in your assumption that it is not going to crash, then your annualized returns are going to be fantastic - regardless of which strikes you choose. I hope this ETF does not represent a LARGE portion of your portfolio.  By the way, if the downside ever does concern you, you have less risky strategies available (collars and equivalent strategies).

Mark D. Wolfinger
The Rookie's Guide to Options:
The Beginner's Handbook of Trading Equity Options