Generating Income with QQQQ Covered Calls and Puts

I've been trading QQQQ calls and puts off and on to generate income. I wanted to share some of my trades and welcome feedback and input. If you have thoughts and suggestions on how I can improve my positions, please feel free to post.

Over the past 10 years, I've been trading calls and puts on QQQQ off and on to generate income. I'm not a speculative investor and prefer to use options to hedge and contain risk and generate cash when possible. I generally do it when I think a market is going to be flat for some time, although how I collar a position can allow it to run a bit in either direction.

If this sounds like total Greek to you, then follow along. I'll try and post a position update every week and by reading, I think you'll get the hang of what I am doing.

First, why use QQQQ as my base security? It's one of the most highly traded and most liquid of the ETFs out there. QQQQ or Powershares QQQ is an ETF that tracks the Nasdaq. Liquidity matters because it lowers the spreads and allows me to trade without losing as much money on the bid/ask.

I don't really want to spend a lot of time explaining options. There are plenty of good resources online but basically, options allow you to manage and control risk. They can also be used as a form of leverage and can be dangerous when investing in uncovered or naked positions. That's not my style or philosophy. I'm a very conservative options investor.

So, here's the trade I sometimes analyze to make based on today's prices.

Buy 1,000 shares of QQQQ at the current price of $48.79.

Sell $1,000 calls of June QQQQ calls at a strike of 50 for $.87.

Then, if I'm nervous about the market I might also buy a long-term put. In this case, a December 2011 put at 48 costs $5.28. Buying it basically provides me with insurance that I can't lost money if the position goes below 48. I'm insured. That insurance costs $5.28 though, which is over 10% the value of the position.

The key to this position is to sell short them calls against the long term put. Because options closer to their call dates decay faster than long term options, I can sell the short term calls quickly and then sell the put before it decays in value. In addition, I've structured the call so that the stock can run up a bit and I can pocket some money on that - since the market is on the upswing.

I'm not crazy about the cash I can get for the call but at the same time, the put is not all that expensive. In an ideal market situation, you would buy the put in a low volatility environment, and sell the calls in a high volatility one. Then, as volatility comes down, you'll also make money on volatility changes.

Once again, this is not a position to double your money in 3 months. It is a position thought that significantly lowers risk and provides a modest return. I'll be tracking the position and will let you know how it does.

Sam Cass
Sam Cass: Sam Cass, MBA, JD, University of Texas at Austin. Always a fan of Leonardo Da Vinci.

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  • joey

    April 16, 2010

    i loved reading this

  • michael

    April 16, 2010

    Over the past 10 years, I would like to know your absolute rate of return.
    can you share it with me?

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