Thursday, January 12, 2012

Book Review: Options for Volatile Markets

Jeff Partlow, blogger and mentor in the covered call community, was among the first to bring the book linked over in the right column, to my attention.  I promptly went out and bought it, drawing from the insights offered to develop my strategy for the Rescue My IRA account.  Jeff (whose blog may be found at http://coveredcallsadvisor.blogspot.com/) recently posted a review of the book on Amazon.com, which I thought I might repost here for convenience.  He is also the moderator of the members only JustCoveredCalls discussion board over on Yahoo (link to the sign-in page, from which you can join the board:  https://login.yahoo.com/config/login_verify2?.intl=us&.src=ygrp&.done=http%3a//finance.groups.yahoo.com%2Fgroup%2Fjustcoveredcalls%2Fjoin).

Here is Jeff's review of the book, in full text:

PRAISE: First and foremost, I confidently assert that this book is the single best resource now available that is focused primarily on the subject of covered calls investing. To those who have read the 1st Edition of this book (titled "New Insights on Covered Call Writing"), this 2nd Edition is a substantial improvement. It is written with great clarity throughout and is worthwhile reading for anyone (from novice to expert) interested in covered calls and other closely-related hedging strategies.

Some of the best features are:

  1. Excellent definitions and explanations of options terminology; and especially insightful discussions of important topics such as time value decay, skews, implied volatility, and historic volatility.
  2. A very good explanation of why a fear common to many newbie covered calls investors, namely early exercise, is largely unwarranted.
  3. Thorough discussions related to position management (the authors call this "follow-up actions"), including various types of "rolling".
  4. The section on "Basic Tax Rules for Options" is the best concise description I've seen anywhere on this topic.
  5. Why it is critically important that investors develop knowledge of how "risk" and "volatility" should inform our investment decision-making process. Consideration of specific "traps" to be avoided is another especially strong feature of this book.
  6. For investors interested in modifications to the basic covered calls strategy, hedging with protective puts, collars, and option spreads are also presented. Thankfully, the authors present these alternatives in a well-balanced manner, taking time to present both the pros and cons of each strategy.
  1. I share the concern of some other reviewers that the revised title of this 2nd Edition is overly generic and therefore somewhat misleading. A more appropriate title would be something like "Covered Calls and Related Hedging Strategies".
  2. Figure 6.4 is a very nice, visual way to portray the "Behavioral Impact of Covered Call Writing". But the stock price ranges are incorrect: "Good decision offset..." should be <$47, etc., etc.
  3. Weekly options now exist for over 100 equities/ETFs and they continue to grow in both availability and popularity. Including commentary on the possible role of weeklies in the several instances when expiration timeframes are addressed throughout the book would definitely enhance the readers' overall understanding.
MAJOR FLAW: On pages 162-164, the authors present results from their own study of four strategies during 2007-2010. The results are summarized in Table 8.3. Unfortunately, there are errors in the "Total Period" column which will cause naïve readers to falsely conclude that the collar strategy provides substantially better returns than the other three strategies.
Two of these errors are:
  • The actual overall performance of SPY over these 4 years was -3.8%, not -17.3%.
  • The +15.2% return claimed for the collar strategy defies basic, common sense when compared with the returns presented for its related component parts, that is a covered calls return of +3.1% in combination with a put hedge return of -5.2%. We can also conclude that the +15.2% is also clearly inaccurate from a different viewpoint, since a time-weighted average of the flat period (+5.8%), down period(+0.4%), and up period (+16.7%) is much closer to +8.4% -- but definitely not +15.2%.
This major flaw should be corrected prior to the next printing of this book. Further, to improve the validity of the results, the current 4-year backtest should be extended to a more rigorous minimum of 20 years.


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