CallWriter SuperPut Strategy Explained

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Using the SuperPut Strategy

Copyright 2007-2009 John Brasher. Used by permission.
CallWriter’s family of SuperPut lists presents something new in covered call lists: covered call trade candidates with a long-dated protective put added to protect the stock’s downside. The covered call trade is built like this:

Covered Call = Long Stock – Short Call

What is a SuperPut?

Because the covered call involves a long stock position, the danger posed to the writer is a sell-off in the stock. The best protective measure to define and limit risk in a covered call trade is to buy a long-term protective put when the trade is placed (known as a married put when the put is bought at inception), which I refer to as a SuperPut trade. The SuperPut position looks like this:

SuperPut = Long Stock – Short Call + Long Put

Recall that a put option gives the holder (in this case, you – the call writer) the right but not the obligation, to sell the stock at a fixed price for a specified period of time. Thus even if the stock price collapses, the call writer who has purchased a protective put will be able, for the life of the put, to sell the stock at the put’s strike price. In the CallWriter SuperPut trade, the long puts shown on the list will have an expiration that is six to eight months out.

Why do I call it the SuperPut? Because the trade involves a long put that does a super job of protecting the underlying stock. These trades really are SuperPuts. We also refer to them as Protected Buy-Write (PBW) trades.

The Top 10 Reasons to Write SuperPuts

SuperPut trades are constructed to provide cheap protection for your stock over the intermediate term, while allowing you to write calls every month to bring in a stream of premium over time. Additional profits can be realized by trading the calls. The advantages of the SuperPut trade – when the long-term put’s cost is cheap in comparison to the current-month call’s premium – are numerous:

1.
Call-Writing Income:
A stream of income can be generated from the monthly call writes. Month in, month out, you continue to write calls against the underlying stock, producing a stream of income. Of course, you can close the trade any time its net position value (buying back the calls, selling the stock and put) shows you a profitable close. Or keep writing for more profits. It’s your choice. And isn’t it nice to have a choice and be in charge?
2.
Call-Trading Income:
Income also can be generated from trading and rolling the calls with the stock’s movement. Unprotected covered call writers can trade and roll calls, too, but the SuperPut frees the trader from worries about risk from a downside stock movement.
3.
The Stock is Protected:
The long stock position is protected for the life of the six- to eight-month put. Think of it: go into a trade knowing that for many months you can continue to cream the stock for premium without fear of the stock’s bottom falling out.
4.
We Show You Only the Cheap Puts:
The long puts on the SuperPut lists for the most part only cost 2x to 3x the current-month call premium, even though the puts have an expiration six to eight months out. Sometimes the put cost is not even twice the call premium. Our research page allows you to instantly look at other put strikes and expiration months. For example, suppose the 8-month put will cost $6.50 but you can buy the next-year’s LEAPS put (17 months out) for only $8.50?
5.
Risk is Strictly Limited:
No trade on our SuperPut lists presents a maximum possible loss that is more than 10% of the net debit incurred to put on the trade. The maximum risk often is much less. Certainly, good trade management can often snatch victory from the jaws of defeat or at least minimize a loss. But wouldn’t you like to buy a $30 stock knowing that $3.00 is the most you could possibly lose, no matter what?
6.
Know the Maximum Risk Going In:
In an unprotected covered call trade, it is never possible to know the maximum risk. For example, even a stock carefully and conservatively selected for a covered call could be hit with bad news and gap down significantly, giving you no chance to manage the trade. But the SuperPut allows you to quantify your maximum risk upon trade entry.
7.
Great in Flat and Even Bear Markets:
Covered calls can be done successfully even in bear markets, even though they work well in bull markets (even if not the most high-octane bull-market strategy) and probably are best in flat markets. But when others are moaning about the “poor” returns available in flat markets, SuperPut writers are stuffing their pockets with great premium. Better yet, when everyone else is running for the hills in a bear market, SuperPut writers are making great returns on falling stocks.
8.
Great on Volatile Stocks:
In a nutshell, covered call writers look for trades offering high returns, which mean that they have high implied volatility, on underlying stocks that are unlikely to be very volatile. The SuperPut, however, allows you to make money on stocks volatile enough to frighten in regular covered call trades. Why? The answer is that the calls can be rolled or traded with the stock’s movement. Traders make money off volatile stock movements, and covered call writers can, too – but SuperPut traders can do it and be protected at the same time.
9.
Turns the Downside Risk into Someone Else’s Problem:
How many trades can be constructed which offer the prospect of generating a stream of ongoing profit and which allow you to turn your potential problem in the trade (a collapsing stock) into someone else’s problem? The SuperPut does.
10.
The Trade Soon Becomes Risk-less:
Once the put’s cost has been recouped (recoupment), the trade becomes riskless. Even if the stock’s price collapses like American Home Mortgage in 2007, you cannot take a loss after recoupment occurs. And for many of the trades on our SuperPut lists, the second call write will recoup the put’s cost; worst case the third (not including) any trading profits.

Now it is time to see what the excitement is all about! We will select a sample trade that in early September 2007, as this is written, offers good prospects as a SuperPut position.

A Sample SuperPut Trade

Our goal in the following illustrative Lehman Bros. Holdings (LEH) SuperPut trade is to generate a good income stream from the sequential writing of calls and to lower the put cost per month. LEH has been volatile, as have all the big brokers in the summer of 2007. This volatility is likely to continue, due to concerns that the brokers will suffer major asset write-downs and hits to income as the housing market dries up sales of financial products, among other woes. The continuing volatility means that 1) premium is likely to stay high, and 2) movement in the stock will provide opportunities to trade the calls for additional profit. This trade appeared on CallWriter’s SuperPut lists.

While we cannot know what the stream of call premium will be, we have fixed the cost of put protection going in. Using actual LEH option prices, we can construct a potential SuperPut trade of eight months’ maximum duration and examine it closely for income potential. The projections of $2.00 per month in call premium are just that – projections – but the table below assumes a conservative level of call premium for succeeding months. There is good reason to think that high premium levels will continue in brokers such as LEH for some time, until the problems besetting them resolve.

Putting on the Trade

In the following SuperPut trade example, we assume a buy of LEH at $54.83, writing the current at-the-money SEP 55 Call for $3.20 in premium (all time value), and for protection buying the APR 55 Put for $6.70. The APR 55 Put guarantees that we can never sell the stock for less than $55, no matter what happens! And the put is a bargain, because we get eight expiration months of protection at $55 and it only costs us $6.70, or $0.83 per month.

The trade costs us $58.33 per share to put on (54.83 – 3.20 + 6.70), or $29,165 if we bought 500 shares.

SuperPut Trade Example (1) (2) (3) (4) (5) (6) (7) (8)
Lehman Bros. LEH SEP
55 Call		 OCT
55 Call		 NOV
55 Call		 DEC
55 Call		 JAN
55 Call		 FEB
55 Call		 MAR
55 Call		 APR
55 Call
Stock Price = $54.83 Jan-08 55 Put
Buy stock 54.83
Write call options 3.20 2.00 2.00 2.00 2.00 2.00 2.00 2.00
Buy protective put 6.70
Net Debit 58.33 56.33 54.33 52.33 50.33 48.33 46.33 44.33
Return on Original Trade Debit (58.33) 5.5% 8.9% 12.3% 15.8% 19.2% 22.6% 26.1% 29.5%
Maximum Risk (Net Debit – 55.00 strike) - 3.33
(5.7%)		 - 1.33
(2.3%)		 + 0.67
$335.00		 + 2.67
$1,335.00		 + 4.67
$2,335.00		 + 6.67
$3,335.00		 + 8.67
$4,335.00		 + 10.67
$5,335.00
Note that computations do not take trade commissions into account.

We could have written the OTM SEP 60 Calls for a $1.30 premium instead of the ATM 55 Calls for $3.20. Doing so would have produced far less premium income, though it would have produced nice profits if the stock were called.

Maximum Risk

Note in the above LEH trade how, in the third month of the trade, the position becomes risk-less and goes into profit.

The long put limits our risk, because for the eight-month life of the put, we can sell the LEH stock at $55. But notice that the risk soon goes to zero. At the time of trade entry our maximum risk – the largest amount we can lose even if the stock goes to zero – is $3.33, or $1,665.00. The second month’s call write for an assumed $2.00 lowers the maximum possible loss to $1.33, or $665 on 500 shares. The third call write at $2.00 makes the trade risk-less and puts it into guaranteed profit. When the third call is written, the trade no longer can lose. In fact, if premium levels continue as high as they are, the second month’s call write could make the trade risk-less, or within pennies of being risk-less.

SuperPut Income Stream

This trade pulls in a total call premium income stream of $17.20 ($8,600), and after recouping the $6.70 put cost, the net premium income stream for the eight months is $10.50 ($5,250.00). That is a clear profit of 18% for eight months; a 27% annualized return. And 5.7% was the maximum possible loss on trade entry. An average premium level of $2.50 per month instead of $2.00 would have added an extra $3.50 of total premium income, boosting return from $10.50 to $14.00 ($7,000.00), for a 24% raw return, 36% annualized. A simple covered call with no put added would have produced far greater returns, since there would not be the financial drag of the long put, but also would have exposed the writer to a far higher level of risk.

NOTE: The LEH table does not include any profits from assumed trading the calls or upon assignment. With a volatile stock the returns could be far greater than assumed in the LEH table above. However, it is important to see how the trade works in conception.

Profits Compounding

As the premium stream rolls in every month, it can be put into other trades. The LEH table above makes no attempt to show the result from compounding premium income by placing it into new SuperPut trades. Bankers refer to it as “turning” capital. As payments come in on loans, bankers lend the money out again right away, turning it into new loans for more returns. Compounding is important, because it keeps your money working with maximum efficiency. The great banking fortunes of history were built precisely on turning their money.

SuperPut Trade Selection

Obviously, we cannot know what the price of LEH or any other stock might be over the coming months, or what the level of implied volatility (IV) and therefore call premiums might be. Just as obviously, we will not make a flat, linear return on the calls as shown in the table above. Therefore, we cannot predict premium except by dead reckoning, which makes assumptions about future levels of implied volatility in the stock. This is why a stock with a high background level of implied volatility, such as LEH or General Motors (GM), make the best SuperPut candidates when the put cost is cheap: because the volatility expectations keep premium high month after month. A stock that consistently hits the CallWriter lists month in and month out are ones with higher-than-normal levels of implied volatility – and thus option premium.

On the other hand, a stock like Olin Corp. (OLN), which historically is not very volatile, might offer high call premium in a particular month as well as cheap long-term put costs. Call premium in succeeding months is unlikely to be good, however, because the persistent volatility expectations will not be there. If Olin should go into a volatile phase because of events affecting it or its industry, that could change. But staid, non-volatile stocks are not great choices for SuperPut trades, because despite cheap put costs they do not produce good call premium.

The SuperPut (and covered call) writer essentially is milking the stock for call premium. And just as the dairy farmer prefers, for the same cost, a cow that gives lots of milk to one that gives little milk, we should look for stocks more likely to produce call premium. The two primary factors that make money for a SuperPut writer are:

1.
Consistently higher-than-normal levels of implied volatility.
Implied volatility (IV) is an expectation that the stock may move – become volatile – in the future. High IV can be caused by a pending event, or by a backdrop of volatility expectations as noted above in the case of LEH and GM. In addition, stocks that tend to be volatile in fact have a high level of IV, as you would expect. I have observed that stocks in very reliable trends, and that therefore make good money for option speculators, tend to have expensive premiums since it is easy to make money on them and Wall Street does not give good returns away.
2.
Actual volatility or a wide trading range.
Stocks with a wide trading range can be excellent, as are stocks that are volatile. Extreme, explosive volatility is not what most SuperPut writers are seeking. But stocks with a narrow true range and that, like Olin Corp., tend to have little volatility, provide scant opportunity for trading the calls.

Basic SuperPut Management

Unlike the situation with an unprotected covered call, we are not normally concerned about a price slide in the SuperPut. Therefore, trade management becomes less about saving the writer’s bacon and more about pulling additional profit out of the position through trading. Here are some common scenarios and basic responses:

1.
The stock drops in price.
Close (buy back) the short call, which should cost substantially less than the premium received upon its sale – this creates a profit. If the stock merely is down in its average range, simply wait and sell the call again when the stock moves back up. This technique is employed where the pullback is not that large and the stock is expected to snap back.Another technique is to roll the calls down (buy back the short calls and sell calls with a lower strike) in order to grab as much of the price slide as possible. Rolling down is explained on CallWriter under Trade Management.
2.
The stock remains essentially flat.
Keep creaming it every month for additional call premium.
3.
Call premium goes flat.
This can happen: the premium is good the first month or so, then goes really flat in the second or third month. Where the stock provides no trading profits, it is basically a waste of time. After recouping the put cost, consider closing the trade once it is in profit. If it cannot get into profit (because you overpaid for the put, premium was only good the first month, or whatever), you must decide whether you are better to take the loss and find another trade. By doggedly continuing to write it, you might save a loss or wind up with a modest return. This situation is precisely why stocks with a higher backdrop of IV are preferred.Give preference to stocks with high premium in both the current and near month, which assures at least a couple of months of good premium. Controlling the amount paid for the put is paramount. For example, don’t buy a put 15 months out just because it is cheap; the 6- or 8-month put might be a better buy.
4.
The stock goes up.
Some writers prefer to roll the calls up (buy back the short calls and sell a call with a higher strike price), which increases the potential profit in the trade – but also increases your debit in the trade.If called out, an easy approach is simply to buy the stock and write it again. However, as the stock rises higher, the less protective the put will become. But on the other hand, the stock is more valuable and in an uptrend.

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  • Mike D
    Jeff,
    1. How do you manage a sharp rise in the stock when you've sold an at the money call? Your Put is eroding and you are not participating in the rise of the stock. When called, do you repurchase the stock where it is and write again with the same Put?

    2. I have noticed that the 8-9 month put price is not that more expensive than the 5-6 month put price. So, do you consider pushing out the Put every few months rather than starting fresh? Example, you have paid for the put in three months of call writing, now when the further out puts are now available, sell the currently held put and buy the farther out on for only a dollar or so more for several more months?

    Mike D.
    PS: I like the new look to the site.
  • Jeff
    Mike,

    Honestly, the only experience I have with a SuperPut is one simulated trade that I did on SID back at the end of June , which I finally sold the Put on a few weeks ago. I wanted to test the concept and see how I would manage the trade. Turns out I didn't pay enough attention to it. The July Call expired ITM and I should have bought the stock back when it pulled back on 8/17 & 18, but instead I sold the Put a few days later. So to answer your first question, yes, you would hang on to you original insurance policy (the Put) and continue to write Calls to reduce the cost basis for the Put and eventually make it a riskless trade. Doesn't work so well, however, if the stock takes off and doesn't come back.

    Regarding 'rolling' the Put - No, I would not do that. Most of the case studies I have seen on SuperPuts shows that the SuperPut is closed long before the Put expires, and the remainder have the Put expiring worthless and the trader simply re-evaluating the trade and either continuing with the underlying without a protective Put, or simply buying another Put 8 months or more out and the right strike (depending on the current cost basis of the underlying).

    You ask some good questions and have good observation skills. Thanks for the food for thought.

    - Jeff
  • Mike,

    I appreciate the comment and thanks for the compliment. So far this has been a labor of love and I hope to keep it that way. I just want everyone (or at least as many people as possible) to share my success and follow me as I learn from my readers and other sources.

    - Jeff
  • Mike
    Thanks for the quick reply and explanation. I searched around a little and see that they call it a "calendar collar" on the callwriter "Super Put Sample List" page.

    I like your underlying techniques and writing style and am excited for your new blog to debut. Thanks -Mike
  • Mike,

    Thanks for the comment. The term SuperPut is a trademark of CallWriter.com and LogiCapital and is also the name of the exclusive list of prospects provided by their service. Usually with a Collar the Calls and Puts have the same expiration month. For a SuperPut, the Calls are Front Month or next month and the Put's expiration is 8 months or more.

    - Jeff
  • Mike
    I like the detail and explanation you put into this. Is there a reason you don't mention it by it's more commonly known name, a "collar?" I was confused at first by the different name, but am convinced it's the same thing...
  • Greg,

    Definitely, but then it would be a spread and not a SuperPut at all (buying a put near the money and selling a put next strike out of the money would be a debit spread and selling a put near the money and buying a put next strike OTM would be a credit spread). If it matters, you would not own the stock.

    - Jeff
  • Greg
    Hi Jeff, gret site!

    My question to you is, would you ever open this superput trade with a naked put instead of a covered call?

    Best,

    Greg
  • Raj,

    A lot depends on the prices paid for each leg of the SuperPut and what works best if the stock appreciates.

    Here are a few things that could be done:
    1)Roll up to the next month prior to expiration.
    2)Let the stock be called, keep the Put, buy the stock back and write another call at a higher strike for the next month.
    3)Same as #2 but sell the Put (if you are bullish) - there still should be a lot of time value left on the Put.
    4)let the stock be called and sell the Put.

    All these have the potential of giving you a positive return while limiting downside risk.

    I think I will do SuperPut trade or two next week - either paper or real. Stay tuned.

    Jeff
  • Raj
    Hi,

    Great post, but have a question for you.

    What would you do with the put when tthe stock goes on a bull run? Would you just sell the put or would you roll the put up to "protect" your gain in the stock? This would obviously affect your cost basis, but what is the right thing to do?
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