Monday, February 18, 2013

Results for Covered Calls On Bonds

Like many, CCI feel that the only way for interest rates to go is up.  To me" the only debate is the rate" of the increase.  Will it be
  •  a slow drift sideways/higher as the central banks of the world continue to keep the short end of the rate curve low and this stunts the growth of the long end of the curve, 
  • will there be a "big  bang" moment when Mr. Market says enough is enough and rates spike.
Given the above overall belief, CCI has generally been reducing exposure to bonds.  In fact, CCI even took some short option positions in bonds which will be the topic of a future post. However, most of the reduction in bond allocation has been moving into a covered call portfolio of equities as an alternate way to generate income and lower the volatility of a pure increase of the equity allocation. 

Additionally, as another alternative,  CCI started writing covered calls against some of the remaining bond position.  This approach should work best if rates just drift sideways/lower as opposed to spiking lower.  In essence this strategy is planning on the premium from options to outpace the rate of decline from rate increases. As stated above, I'm not sure of the pace of the interest rate increases, and it is even possible I'm totally wrong and rates somehow fall more. (yes, I know it is shocking to think about it....but I am wrong from time to

I wrote the first call against the long term US treasury bond ETF (TLT) on July 7, 2012.  For the remainder of the year nine covered calls positions were taken and closed.  The option strikes were based on market conditions, but usually written 1 to 3 weeks out in the future and about 2 % out of the money.  Seven of the option cycles were winners and two were losers for a net premium collected of 3.3%.  Unfortunately the underlying fell 3.8% (5.0% capital loss less 1.2% in dividends collected).  So these covered calls turned a 3.8% loss into a 0.5% loss. Early results for 2013 are similar.

Obviously, with perfect hind sight it would have been better to totally exit the long-term bond position, but at least this approach reduced the loss, and will generate a positive return if there is a run back the safety of treasure bonds.

 CCI will start tracking these covered calls as part of the ICC portfolio going forward.

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