FOREX income strategy combining covered calls and scale trading

DISCLAIMER: I'm not a financial adviser. You can lose more than you invest when trading FOREX. Proceed at your own risk.

1-line summary: Buy USDCAD at 25-pip multiples and sell the nearest-expiring covered call. If call expires worthless, keep selling nearest-expiring covered call until it's exercised.

Strategy:

• Whenever USDCAD is at a multiple of 25 pips (eg, 1.0525, 1.0550, 1.0575, 1.0600, etc), buy $25K of USDCAD and sell $25K of the nearest-expiring FX spot covered call (usually 2-3 business days out) with the same strike price as your purchase price.


• Once you've traded (bought USDCAD and sold the call) at a given multiple, don't trade that multiple again until the call you sold is exercised. Example: if you buy USDCAD at 1.0525 and sell the covered call, and USDCAD goes up and comes back down to 1.0525 before your call is exercised, don't trade again at 1.0525, because the call you sold has not been exercised.


• If your call expires worthless, sell $25K of the next nearest-expiring covered call at the same strike price. Repeat until the call is exercised (which may take days, months, or even years). In this way, you'll always sell USDCAD at the same price you bought it, even though it may take a long time.


• Exception to rule above: if the next nearest-expiring call at the same strike price has bid zero, use the nearest expiration date with non-zero bid. In other words, don't sell a covered call for nothing.


• Once the call you sold is exercised, you can again buy when USDCAD hits the same multiple of 25 pips. Example: you buy USDCAD at 1.0525 and sell the covered call. USDCAD goes up and your call is exercised. Then, USDCAD goes back down to 1.0525. At this point, you would buy USDCAD and sell the call again, since the call you sold previously has been exercised.

Notes:

• This strategy is for $150K. Adjust for other amounts. This strategy scales down to $6K, since you can buy as little as $1K of USDCAD.


• This strategy protects up to a 15% loss in the USDCAD. If USDCAD drops 15% and you've been buying every 25 pips on the way down, you'll have 60 positions with an average loss of 7.5% or $1875. Adding in the 2.5% margin requirement, your total loss will be $150K (the amount you started with) minus what you've received for writing calls. Some brokers have lower margin requirements, which means you can withstand a slightly larger loss.


• Treat this as an income strategy: you're looking to make money by writing calls, and not worry about the gain/loss on USDCAD. This is similar to a stock that pays a constant dividend, regardless of price.


• This strategy combines covered call writing and scale trading, two well-known existing strategies. I don't know if anyone's combined these before


• It's difficult to find FOREX brokers who trade FX spot options (which expire daily). The only two I've found are ikongm.com and saxobank.com. pfgbest.com trades them too, but they use ikongm.com as their back-end. All three offer a free demo account.


• Many brokers trade FX futures options (which expire monthly), but this isn't the same thing. Make sure to confirm your broker trades daily FX spot options


• Of course, you can trade USDCAD with one broker and USDCAD options with another. For example, unlike ikongm.com/saxobank.com/pfgbest.com, forex.com pays 2.5% interest on balances and accepts credit cards for funding. However, if you split brokers, there are additional complications


• If signing up with one of these brokers, please mention kelly.terry.jones@gmail.com sent you. I don't have deals with any of them, so I probably won't get anything, but who knows!


• There are endless variations on this strategy: which currency to trade, how to set your scale, how much to invest at each scale point, etc. As with all scale trading, you want to trade something that won't go down much further. When selling covered calls, you also want something that has a high volatility, so you get a good price for the calls. I chose USDCAD for these criteria, but I'm sure there are other good currency pairs (USDJPY in particular looks quite interesting)


• This strategy is unusual in that it doesn't rely on patterns, technical analysis, back-testing, etc. Instead, it's based on statistical formulas such as the Black-Scholes-Merton formula. This doesn't make it any better or worse than other strategies: it's just an observation