Coverd Call and beta hedging

Good question, please post it as a comment at the blog:

If you are familiar with the CBOE Buy-Write Index (Covered calls on the S&P 50o0 index), then you should know that they have an equivalent index on writing 2% OTM calls instead of ATM calls.  It has performed better over the years.  Obviously that's because the market has trended higher.

You cannot 'just collect the premiums' because a bear market will hurt.  However, writing calls that are 2% OTM is viable.  To me 5% is just too bullish - but there is nothing wrong with that idea - in principle.

What I may not understand is your question about shorting. A buy write just shorts the calls. If you want to be market neutral, rather than long, one way to do that is to overwrite - i.e., take he risk of selling extra calls to reach delta neutrality.  Many brokers won't allow that play (naked short calls, but you can get around that by selling call spreads instead.  But please - do not sell too many.  I don't get why this market does nothing but move higher, but it's foolish to fight the reality that we see.

Instead of shorting a high-correlation index, why not just short the index you are trading. Correlation guaranteed to be 100%.  You do that by owning less stock - or, selling more calls.

It will work if the market does not make a major move in either direction.


On 2/18/2011 8:46 AM, wrote:
Hi Mark,

Just wondering what you thoughts are on a index buy-write
(ATM, 2% or 5% OTM?) strategy that uses either options or
short selling to hedge the residual beta i.e. shorting a
high correlating index? The idea being to be market neutral
and just collect the premiums. Would this work?

Many thanks, Sam

Mark D Wolfinger