The first time I looked at an options chain it reminded me of the first examination I took in Organic Chemistry…..I thought I was prepared for it but boy was I wrong! However, like most challenges (except perhaps organic chemistry), these hurdles can be overcome by simply doing your due-diligence and via repetition. For many experienced cover call writers, the knowledge gleaned from the options chain has become second nature and a source of information for our lucrative returns. Knowing how to read an options chain is an essential prerequisite (what’s with all these college references?) to writing covered calls or any form of options trading.
Definition of an options chain:
It is a list of option prices of a particular underlying security (stock, ETF etc.) for various strike prices, expiration dates, and option types (calls and puts). Here is what a typical options chain looks like (for call options only):
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View By Expiration: Jun 09 | Jul 09 | Oct 09 | Jan 10 | Jan 11
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The components of the option chain (from left to right):
1- Strike price- Also called the exercise price. For call options, this is the price at which the option holder (buyer) can purchase the underlying security. They usually trade in $2.50 increments under $25, $5 increments above $25, and $10 increments above $200. There are exceptions as in the case here.
2- Symbol- These are the ticker symbols for options. They identify the underlying equity, the strike price and the month of expiration (the specific date is always the third Friday of that month). The etiology of these symbols is explained in Chapter 5 of Cashing in on Covered Calls.
3- Last- This is the price at which the last trade of that particular option was executed at. For example, the $20 strike was last traded @ .85.
4- Change- This column describes for the trader how much that option has risen or fallen since the previous market close. In this example, the $15 strike has increased in price by .60.
5- Bid- The price at which the market makers are willing to buy your option. It is the price when you sell an option (sell at the bid, the lower price).
6- Ask- The price at which market makers are willing to sell the option. It is the price when you buy an option (buy at the ask, the higher price).
7- Volume (Vol)- The number of contracts traded for that option during the trading day. The higher this daily volume, the more liquid this option contract becomes as compared to options with a lower daily volume. However, because each day brings a new daily volume, it is not the most accurate measure of option liquidity. Furthermore, getting information on past daily volume is much more difficult to obtain than the vast information available on stocks.
8- Open interest- The open interest of an option contract is the number of outstanding options of that type which currently have not been closed out or exercised. So if the open interest was 1,000, this means that there are currently 1,000 options that are still active to be exercised or sold. Because an option is simply a contract, more can be created every day, but the current open interest gives investors an idea of the interest that investors are showing in that contract type. The higher the open interest, the more liquid the option contract is thought to be.
An example using the above options chain:
First, let’s make up a name for this company….okay, I got it: BCI Corp.
- We buy 100 x BCI @ $20
- We then sell the at-the-money $20 strike @ .84 sell at the bid, the lower price
- Our 1- month option return (ROO) is 84/2000 = 4.2% = 50% annualized
Analysis of this example:
The options chain tells us the symbol for the $20 strike (MQF-FD) and the fact that it is up in price by .26 for the trading day. We also see that this strike, along with the $21 strike have the highest liquidity of the available options. Also note that on the top of the chain, we are told that these are call options and that the expiration date is June 19, 2009.
The bid-ask spread:
The amount by which the ask price exceeds the bid. This is essentially the difference in price between the highest price that a buyer is willing to pay for an asset and the lowest price for which a seller is willing to sell it. In the above options chain, for the $20 strike the spread is only .01 (.85 - .84). In many cases, the spread will be much larger presenting us with an opportunity to sell at a slightly higher price than the bid or buy at a slightly lower price than the ask. Earlier this year, I published an article on how to play the bid-ask spread. Here is a link to that column:
To those of you new to options, I assure you that by studying and viewing options chains, in a relatively short period of time, they will become second nature to you. Organic chemistry (my nemesis…never could get that A!) is another story.
Exit Strategies for Covered Call Writing- The Book (not the movie):
Earlier this week, I sent an email to all those on my mailing list announcing the publication and availability of my latest book. The response has been overwhelming and I deeply appreciate your support and confidence. This book was written because of the many requests that I received asking for more information on exit strategies for cc writing. I thank you for your feedback as it allowed me to enhance this aspect of our system and clarify to you many of the maneuvers that I make automatically after years and years of trial and error. I decided to package the book with an Expiration Friday DVD I previously produced, since these end of the contract exit strategies can be big money-makers for us. In keeping with my Blue Collar philosophy of holding prices down, the book and DVD are priced @ $24.95 for both. The DVD can only be accessed from this website. For a short time, I have put up a pre-order form (shipment will begin next week based on dates orders are received) which will give you a discount of $5 per book/DVD package. Here is a link to that form:
http://www.thebluecollarinvestor.com/store.shtml
I STRONGLY URGE YOU TO VIEW THE VIDEO ON THE HOMEPAGE…see below.
Last Weeks Economic News:
The only negative news was housing, which needs a boost of demand. Sales of exisiting homes was up 2.9% in April, no change from back in October. Median home prices were about 15% lower than a year earlier. On a more positive note, the overall economy is contracting at a slower pace than initially expected. In the 1st quarter the GDP fell by 5.7% versus an estimate of 6.1%. Consumer sentiment increased for the second straight month. This is important as perception is critical when it comes to the strength of the stock market. Also positive, was the fact that durable goods orders increased by 1.9%, much more than expected. For the week, the S&P 500 rose 3.6% for a year-to-date return of 3%.
Video now playing on the homepage: Multiple Exit Strategies in the Same Contract Period (just created):
http://www.thebluecollarinvestor.com/
Hope to hear from you. Your feedback is essential to the quality of this site.
Best regards,
Alan
12 responses so far ↓
1 admin // May 31, 2009 at 4:22 am
WE ARE CURRENTLY EXPERIENCING DIFFICULTY WITH MY NEW VIDEO ABOUT MULTIPLE EXIT STRATEGIES. We are working on the problem…wouldn’t you know…opening night and the show can’t go on!..
Should be fixed soon. Check back later…will be worth your time.
In the interim, I put up another exit strategy video.
Alan
2 admin // May 31, 2009 at 8:24 am
The problem with the video was related to traffic on the YouTube servers. It seems to be working now:
http://www.thebluecollarinvestor.com
Now you know why I have all this gray hair!
BTW: The first shipment of my new book will begin tomorrow.
Alan
3 admin // Jun 1, 2009 at 1:19 pm
BUYING BACK AN OPTION THAT IS CURRENTLY OUT-OF-THE-MONEY:
Since the market has been going up, I’ve had some email questions about buying back options early in the contract period if the stock price is well above the strike. Generally, this does NOT make much sense to do.
For example, I sold the $17.50 strike for RHT. It is currently trading @ $20.77. My shares are worth $17.50 at this point in time. To buy back the option, I would pay $3.40 (check the options chain). That means I would own the stock @ $20.90 (17.50 + 3.40), .13 above market. If you think that the stock is going a lot higher than this may make sense. However, in todays market, we could experience a severe drop just as easily as the nice upswing we had today.
The way I look at my situation is that I had a great 1-month return with the sale of the option and now have $3 + downside protection. As we approach expiration Friday (June 19th) if the stock is still above the strike, we’ll consider a rolling out or rolling out and up exit strategy assuming no ER interference.
Alan
4 Richard G. // Jun 2, 2009 at 8:13 am
Alan,
Referring to your video on Multiple Exit Strategies: Why is it inecessary to buy back the call at the $30 strike price? Couldn’t you just sell the other call, at a lower strike price, and simply let the first one eventually expire?
Richard (still a beginner, but trading real money…)
5 admin // Jun 2, 2009 at 9:35 am
Richard,
Thanks for your excellent question. You can only sell 1 option contract per 100 shares of stock. If you sold a $30 call on 100 shares of MVL, you cannot then sell the $25 call on those same 100 shares and still be in a “covered” or protected position.
When you buy back the $30 call, you no longer have an obligation to sell those shares, you simply own them “long” as if you never sold the first option. At this point you are free to sell another option or sell the stock or take no action.
Let me know if this satisfactorily answers your question.
Alan
6 admin // Jun 3, 2009 at 6:44 am
CALCULATIONS:
There are some interesting Q&As JUST POSTED on last weeks blog article. See comments 12, 13, 14 and 15 under this article. Here is the link:
http://www.thebluecollarinvestor.com/blog/dark-pool-liquidity-secrets-of-the-institutional-investors/#comment-1179
Alan
7 admin // Jun 3, 2009 at 11:53 am
WMS is a stock highlighted frequently on this site the last few months. This stock has actually DOUBLED in price since March.
After the last ER in April, I purchased WMS @ $32.90 and sold the $30 call. The stock then went up to $35. That left my original option profit with $5 of downside protection. Since that time, the stock has given back $3 (profit-taking?). I currently still have $2 + of protection of my original option profit. If the stock drops further I will start to prepare for a possible exit strategy play but right now I’m still sitting pretty with this deal.
This shows the comfort that I-T-M strikes provide. You just have to promise yourself that you won’t cry if your stock heads north permanently.
Alan
8 Richard G. // Jun 3, 2009 at 3:39 pm
Thanks Alan. You answered my question.
Richard
9 admin // Jun 4, 2009 at 5:53 am
WALMART CHANGES POLICY:
WMT has announced that it will no longer report same store retail sales statistics. As you know, these reports create similiar volatility to earnings reports and are therefore “banned” from our system of cc writing. WMT is no longer on that banned list. Currently this equity does not pass our screening criteria but it may in the future so let’s keep an eye out to see if we can make some Blue Collar Cash from this company down the road.
I will be providing you with a complete, updated list of companies banned from consideration for this reason, as part of my upcoming published blog article (this weekend).
Alan
10 admin // Jun 5, 2009 at 6:06 am
Strike selection at the end of the contract period:
As time value of the option premiums erode towards the end of a contract cycle, we will have one less choice of strike price than we did at the beginning of the cycle.
When a contract period begins, we choose from in-the-money, at-the-money, and out-of-the-money strikes. All offer good returns and possibly also downside protection or upside potential.
In the end of the cycle the I-T-M strike becomes less attractive. Here are some examples as I write this post:
O-T-M
Buy INT @ $48.51
Sell June/ $50 call @ .90
ROO = 90/4851 = 1.9%
Upside Potential = 149/4851 = 3.1%…not bad.
A-T-M:
Buy AAP @ $44.71
Sell June/$45 @ $1.15
ROO = 115/4471 = 2.6%…pretty good.
I-T-M:
Buy INT @ $48.51
Sell $45 call @ $3.50
ROO = 350 - 351/4500 = 0%…give me a break!
It is very difficult to sell a cc option and receive downside protection in the final 2 weeks of a contract period; impossible in the last week.
Alan
11 admin // Jun 6, 2009 at 6:19 am
Don’t miss tomorrow’s journal article. Guest author, Tony Covino, writes about a stock highlighted by Jim Cramer on his “Mad Money” TV program. Several investment choices, with calculations, will be provided.
Also, I will be updating the “Monthly Same Store Retail Sales” list. These are companies that report sales on a monthly basis and create share volatility that we want no part of. Therefore, these companies are banned from consideration in our Blue Collar System. This list will be slightly different from the one published on page 138 of “Cashing in on Covered Calls”, so be sure to print out the list so as to avoid these equities.
Alan
12 Dave // Jul 2, 2009 at 8:49 am
Hi Alan, I’m reading your exit strategies book and have two questions.
1) For the 20% rule why not just put in a buy order at that price as soon as you sell the call? I’ve seen cases where the stock and option will just take a dip during the day and if you weren’t watching you would miss it.
2) In several of your examples the stock is trading below the 20d ema. How long do you let a stock do that before you get rid of it?
Thx,
Dave
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