Letting it all get called away

Backtest Notebooks

From the moment the tooth fairy first drops dental earnings under the pillow, investors are focused on savings.

Initially it’s to buy that new stuffy, or perhaps a suction cup bow and arrow. Then expenses get bigger, and we want a new stereo, car, or maybe one day a house. Retirement (or career freedom, or {Fill in the Blank}FIRE) awaits at the end of a long string of paychecks, and the best way to get there sooner is to increase the funnel. One big check does it too.

But as soon as you turn off the weekday alarm clock, the investor's mentality must do a 180. Or maybe it’s sooner than retirement, relying on savings in between opportunities, or while launching a new one. In either case, the distributor is doing the opposite of the saver.

All options strategies provide the rigor (and risks) of expiration - a fixed end date for your position. Short calls against underlying stock that settle in the money are contractually obligated to sell shares. That can be a good thing.

Long term investors that are running overlays will often make the decision to roll their position “up and out.” But for investors that are focused on the distribution phase, sold shares become withdrawable cash. Mediterranean cruises aren’t priced in shares of SPY.

When using options to generate cash flow, it’s desirable for shares to get called away, and the writer is paid a premium to lock in a price early.

This week in Backtest Notebooks, we’ll analyze the results of different distribution schedules using covered calls. How should we adjust our overwriting parameters as the path gives us more and less cash?

Spoiler, a lot better than an ETF does.