When we buy a stock, here are the 5 things that can happen to the price:
- it can go up a lot
- it can go up a little
- it can stay the same
- it can go down a little
- it can go down a lot
We, as covered call writers, make money in the first four scenarios. Pretty good odds! We must avoid the last situation where the stock declines dramatically. One of the ways we do this is by employing technical analysis tools. We look for uptrending stocks with the short term moving average above the longer term average. We want the price bars to be at or above the short-term moving average. This is inherent in our system requirements. In this article, we will highlight support and resistance, one of the features moving averages provide to us. I briefly discuss this topic on pages 65-66 in my first book, Cashing in on Covered Calls. First the derfinitions:
Support- The price level at which the demand for a stock is expected to be strong enough to prevent the price from declining further. For economic majors, demand is beginning to overcome supply. This is the point where the bulls take charge. Support levels are generally below the current market value, but stocks may trade at or near support.
Resistance- The price level at which selling is expected to be strong enough to prevent the price from rising any further. Supply is beginning to overcome demand. This is where the bears are in control. Resistance levels are usually above current market prices but equities may trade at or near the resistance level.
Moving averages can be used to identify support and resistance and works best with trending averages as opposed to sideways or consolidating charts.
Trading range- A period of time when prices move in a relatively tight range. The battle of the bulls and the bears is a standoff as the forces of supply and demand are evenly matched. A break above the range on high volume is an extremely bullish signal whereas a break below is bearish.
Moving Average as support:
Let’s take a look at a chart that meets our maximum technical moving average requirements. That means that the price chart is uptrending and the short-term moving average is serving as price support where the OHLC bars are at or above the moving average:
SUPPORT- STEC
I have highlighted with green ovals six points where the price declined to the uptrending moving average. In these instances the average served as support as the price bounced back up, thereby confirming the uptrend. The one instance where the price dropped below support is highlighted by the purple arrow and was a result of an earnings report. Those who follow my system criteria would NOT have owned this stock at that time. You can also see the huge volume spike that the report created, quite typical of an ER.
Here is another chart demonstrating a similar uptrending moving average serving as price support:
SUPPORT- BCSI
Conclusion:
By identifying a favorable trend where the moving average is serving as price support will increase the chances that the stock price will fall into one of the top four favorable categories I mentioned at the beginning of this article. Despite promises and guarantees from those myraid of TV infomercials, stock and market predictions cannot be 100% accurate. What we can do, however, is throw the odds well in our favor. Identifying uptrending moving averages that are providing price support is one important way of accomplishing this.
Upcoming Events:
1- I will be doing another live radio interview (I’ve never met a microphone that I didn’t want to speak into!) on Friday February 5th @ 8:30 AM. Details to follow.
2- I will be teaching a basic covered call class on behalf of The Learning Annex on Thursday April 8th from 6:45 to 9:30 PM. This will take place in New York City. The exact location to follow.
My recent live radio interview with Jordan Kimmel:
Audio clip: Adobe Flash Player (version 9 or above) is required to play this audio clip. Download the latest version here. You also need to have JavaScript enabled in your browser.
Last Week’s Economic News (another mixed bag):
- December retail sales were down 0.3% when analysts expectations were for a 0.5% improvement
- The U.S. trade gap widened although mainly due to increased trading volume, a sign of economic growth
- Consumer prices rose by 0.1% but inflation still remains in check
- Business inventories rose slightly for the second consecutive month as corporations expect an increase in sales
- The Beige Book reported continued economic improvement in 10 of its 12 districts
- For the week, the S&P 500 was down 0.8%
Next Week’s Economic Reports:
Wednesday: Producer price index and new residential construction
Thursday: Conference Board’s index of leading economic indicators
Video playing on the homepage:
Selling Covered Calls- Parts 1 and 2
Much success to all,
Alan
35 responses so far ↓
1 Gary // Jan 17, 2010 at 8:50 am
GaryM // Jan 16, 2010 at 6:48 am
Alan,
Any thoughts on precious metal stocks or their ETF’s?
2 admin // Jan 17, 2010 at 8:51 am
Gary,
In my view, precious metals at this point in time represent a mixed bag which means we probably can do better in the short run with 1-month calls. For long term investors, it represents a more attractive opportunity.
Here are the pros as I see it:
1- a weak dollar bodes well for these precious metals
2- China’s insatiable demand for raw materials continues to present positive long term momentum.
Here are some cons:
1- Negative price momentum for gold and silver: in the last 4 months this group is up 14%; in the last 6 weeks it has remained the same and in the past week, down 4%.
2- The gold and silver group is in the bottom third as far as NEW institutional money entering.
For those looking to explore PM ETFs, here are some with options:
GLD
XME
GDX
IAU
DGL
For a more complete list of PM ETFs:
http://etf.stock-encyclopedia.com/category/precious-metals-etfs.html
Note that two of the newest PM ETFs that have been sparking tremendous interest do not as yet have options:
PALL- palladium
PPLT- platinum
Alan
3 Dave D // Jan 17, 2010 at 9:03 am
Dave D // Jan 16, 2010 at 10:23 pm
Hi Alan,
Currently I own RAX which is due to release its Earnings report this option period (according to Earnings Whispers).
I am considering holding the stock for a few days, perhaps up to a week, in order to sell the stock at a higher price than what it is currently…
What are your thoughts on this stratergy?
Also, what resource do you use for earning report dates? I have noticed that Earnings Whispers and OptionsXpress release different dates.
Hope all is well Alan,
Dave
4 admin // Jan 17, 2010 at 9:14 am
Dave,
This IS a viable strategy particularly when we have a 5-week contract cycle which we do have for the February contracts. Time value will erode only slightly during this first week so holding onto your stock and waiting to move to a different equity will NOT harm you from an option -premium vantage point. Waiting 5-7 trading days is something I oftentimes do with equities I like.
Regarding the sites for ER info, I use earningswhispers.com as my main source and the following as a backup:
http://moneycentral.msn.com/investor/market/earncalendar/
You will notice that on the earningswhispers info, they have a note as to whether the date is confirmed or not. Accuracy is much greater if confirmed. The company itself may not be sure if information will be made public on a specific date if weeks in advance.
Another approach (if you have time) would be to go the the company website, get the phone # for “investor relations” and call them.
Bottom line: if unsure if the company will report in that contract period….stay away!
Alan
5 Don B // Jan 17, 2010 at 10:18 am
Hello Alan,
I just finished reading your informative Support & Resistance work. Marvelous. One thing that has always bothered me, tho, and perhaps others, is that of Volume. When the price dropped, in both your examples, the volume skyrocketed. This implies heavy selling, yes? And yet, for every seller there must be a buyer, yes? Will you enlighten me as to how I am to interpret this information? TIA.
Don B
6 Don B // Jan 17, 2010 at 11:05 am
Re Post #2 – I have observed in the past when something new is presented – such as the ETFs for Palladium and Platinum – that the price moves up powerfully for awhile. Seems prudent to hold off of entry until some sort of equilibrium takes hold. FWIW.
Don B
7 Rohit // Jan 17, 2010 at 11:33 am
Hey Alan,
Couldn’t we also get the ER date from the IBD 100 charts? That way we can get the information in the same place.I have not found a descrepancy between the dates until now. I would tend to confirm the dates with earningswhisper.com for those options who would get a place in my portfolio.
I am eagerly waiting to plunge into the real world after months of paper-trading using the BCI method from Feb. One of the stocks in my watchlist for feb is VRX. Any thoughts?
Thanks
Rohit
8 Don B // Jan 17, 2010 at 11:48 am
Rohit:
RE # 7 – I note it is a health care stock. Perhaps the U.S. Congress at this point might represent something of an “ER” . And currently for sure. The numbers here look nice, but I personally have learned the hard way that getting involved where the government is involved is often a loser.
Just an opinion. FWIW.
Don B
9 admin // Jan 17, 2010 at 2:35 pm
Don,
You are quite right….for every buyer there is a seller, so why is the price dropping like a lead balloon after these ERs?
1- Market makers and specialists are required to provide for a fair and equitable market. They must take the other side of a trade as provided by the “show or fill rule” I wrote about last week.
2- Economics 101: supply and demand- there will always be an equal # of buyers and sellers but at what price. When there is a negative ER surprise owners are dumping and buyers are picking up what they perceive to be “bargains”. Just like selling your old clumker. If you want 8k for it while the tires are falling off, there will be an equal # of buyers and sellers….ZERO! Now you lower your price to $500 and your piece of junk is someone else’s dream car…equal # of buyers and sellers….one….but at what price?
Alan
10 admin // Jan 17, 2010 at 2:42 pm
Rohit,
You definitely can obtain ER info from the IBD 100 charts. But if a stock is not on that particular week’s IBD 100 but may still be on your watchlist, you will need to access the info from one of these sites. Also, if you are looking up a stock that is on the IBD 100 that week, specifically for an ER, these stocks are not alphabetized… let the fun begin! But you are 100% accurate that while you are scanning that week’s list and find a stock that is in, like VRX, jot down the ER at that time …great point.
VRX does meet all our system criteria. Unless you are unhappy with the calculations or have a market-related concern like Don alluded to, it would be an eligible equity to consider.
Alan
11 Dave D // Jan 17, 2010 at 3:57 pm
VRX
I too was considering purchasing this stock. The things that impressed me was that ALL athe technical indicators look positive. Smart select ratings were all green. AND, it achieved an MSN stock scouter rating of 10!
But, I did have a look at the stock info and saw the following:
“Sector: Medical
Industry: MED-DRUGS
Valeant Pharmaceuticals International is a global, publicly traded, research-based specialty pharmaceutical company that discovers, develops, manufactures and markets a broad range of pharmaceutical products.”
Is it a concern when a stock is in such an industry? Can it pose a threat, on the basis that the company could release negative news about one of its drugs ect? Or be impacted by the FDA?
Dave
12 admin // Jan 18, 2010 at 5:09 am
NTY:
Due to report earnings next week, this company came out with a preliminary report of earnings growth up 14% for the quarter. Analysts are estimating yearly growth of about 50%. Other impressive fundamentals include:
- PEG ratio of 0.90
- ROE of 15%
- PE ratio of 12.6 times forward earnings
Let’s re-check the system screens again after the ER on the 25th to see if this equity still belongs on our watchlists.
Alan
13 Eric R // Jan 19, 2010 at 7:56 am
Hi Alan -
I noticed your option log in last weeks blog for your October 2009 ITM options. I had a question about my option log and how I should be recording stocks where I roll out and up. For example: I bought BCSI for 26.91 on 12/14 and sold the 25 strike for 2.60. I bought back that call for 3.70 when the stock was trading at 28.60 and sold the 30 strike for .90. This generates a loss of 2.80 for the current month, but I now own the stock at 28.60 not 25 (or actually the current value which is 29.75 as of the last trade). How do I record something like this in my option log? Do I just record a loss as of now on the option, but when I finally sell the stock record the final sale.
Thanks for your help
Eric
14 Joshua // Jan 19, 2010 at 9:02 am
Alan,
I am looking at VIT right now…current price is 19.90 and $20 call for Feb gives $1.20 in premium….roughly 6% monthly gain (if i dont employ any exit strategies) the reason i chose this is becuase i dont have enough capital left in my scottrade account to buy the pricey stocks (100 at least). whats your analysis of VIT? all greens on IBD 6 point check list and there are no ER coming out….
thoughts from everyone appreciated.
15 Steve Q. // Jan 19, 2010 at 9:21 am
Joshua:
I sold the VIT 20Feb call a week or so ago. Since then the chart has broken down some below the 20 day in somewhat higher volume. MACD also appears to be turning negative so I would watch it for a few days if I were you and see what it does. Just my .02.
16 Eric R. // Jan 19, 2010 at 10:26 am
I also sold the Feb 20 on VIT over a week ago. I agree with Steve Q. that since I purchased this it has been trending neutral to negative. Check out CHSI if you get a chance. Chart seems perfect to me. I just bought at 40.28 and sold the Feb 40. This seems like a safer play IMHO.
Eric
17 admin // Jan 19, 2010 at 10:31 am
Eric,
My response will be from a non-tax perspective, although the upcoming “elite calculator” will have a schedule D attached for such determinations
Your original sale looks like this:
ROO = 260 – 191/2500 = 2.8% (with lots of downside protection).
For your rolling out and up, your cost basis is $2500 per contract because of your original obligation.
Your option loss is 370 – 90 = 280/contract but your share appreciation because the “ceiling” is raised becomes + $360 (at the time of this exit strategy).
Your 1-month return on this :
360 – 280 = 80/2500 = 3.2%
If the stock surpasses the new strike of $30, you gain an additional $140 per contract with a potential 1-month return of:
80 + 140/ 2500 = 8.8%
If the stock goes down below $26.80, it will start to erode the 3.2% profit. The “what now” tab of the Ellman Calculator will give you these figures as well.
Nice job!
Alan
18 admin // Jan 20, 2010 at 5:15 am
CTSH:
Had a positive ER on November 3rd with revenues up 16% year to year. Analysts are projecting growth rates between 15 to 20% per year. Check the chart pattern to see if this equity belongs on your watch list.
Alan
19 DaveP // Jan 20, 2010 at 9:31 am
RDY is on my watch list and had a nice chart pattern as of last week. Unfortunately they just announced earnings and had a loss. Stock is down 8%.
Alan, any idea when your premium service will be announced?
Thx,
Dave
20 admin // Jan 20, 2010 at 11:48 am
Dave,
Many years ago, when I started writing CCs, I was burnt by ERs just like this one. That’s why I instituted the “no ER rule” in our system.
The weekly update and watch list premium package IS ready and we’re extremely proud of it. Our web technicians and programmers are expanding this site to accomodate the premium membership link. We are very close. All those on my mailing list will get a first look and opportunity to join. You can join this list from the “join mailing list” from the homepage of this site.
Alan
21 Eric R. // Jan 20, 2010 at 12:06 pm
Alan –
Thanks for the explanation above for the options log and the update on the premium service. Would you say this service would eliminate the need for a weekly IBD subscription? Also, is the elite calculator rolling out the same time as the premium service?
Thanks
Eric
22 admin // Jan 20, 2010 at 4:22 pm
Eric,
Technically no, you will not need this subscription because you will end up with the same quality watch list that I use for my stock selection. However, there are advantages to keeping the IBD service:
1- for newbies, it will show you how and why my screening process works.
2- it will allow you to screen other stocks that you may have found on your own.
Bottom line:
essential?….no
does it have perks?…yes
I’m hoping to have the “Elite Calculator” available also in the very near future.
Alan
23 Barry Bergman // Jan 20, 2010 at 6:24 pm
Alan,
Since we’re discussing support and resistance this week, I’d like your thoughts on the following relative to selecting strike prices in this “iffy” market:
[1] Look for solid support…both current and historical
[2] Select a strike price where the cost basis (net debit) is at or just below this support
[3] Ideally, this would give a little more ’safety’ to the trade and potentially increase the odds of a successful trade.
Thank you,
Barry
24 Dave // Jan 20, 2010 at 6:57 pm
Hi Alan,
With the down market today I noticed that a few of the stocks that I was looking to buy don’t have charts that look as good as they did. CTSH is one example. The slow stochastics has dropped below 80 and the MACD histogram is approaching 0. What’s your thought on how to proceed in this case? Wait a few days to see if they recover or go ahead and buy since the whole market is down versus a specific stock?
Thx,
Dave
25 Don B // Jan 20, 2010 at 8:05 pm
Alan & All —
My Fidelity page, Earnings & Dividends, shows that CTSH has an expected ER date coming up on Feb. 9!!!
And Alan, I shall anxiously await your comment on Dave’s inquiry (post 24).
Also, am I to understand that your new Premium service will cover all the ground usually covered by your analysis system? (Saving me a lot of work as well as an IBD subscription?)
TIA.
Don B
26 admin // Jan 20, 2010 at 10:09 pm
Barry,
Your comment is right on the money! Selecting an I-T-M strike that is at or near support is a sensible, conservative strategy. Now, if the strike turns out to be deep I-T-M, the time value of the premium may not be worth the investment, so we must do our calculations as well. Excellent point!
Alan
27 admin // Jan 20, 2010 at 10:19 pm
Dave,
Whenever we are in a 5-week contract as we currently are, I allow myself to enter my positions at any time during week #1 as time value erodes slowly and holds up well this first week. If I see a stable market Thursday, I will enter my positions. If not, I will wait for Friday. Still volatile? I’ll sell predominently I-T-M strikes as Barry suggested above.
I must tell you that there are some CC experts who like to sell O-T-M strikes after a “down day” figuring that these staocks will bounce back. This is a more aggressive strategy that has its merits but doesn’t fit my personal conservative approach.
Alan
28 admin // Jan 20, 2010 at 10:35 pm
Don,
When I mention a stock like CTSH that may be appropriate for your WATCH LIST, I leave it to your skills and due-diligence to check ERs, technical analysis and calculations to determine if its appropriate for your PORTFOLIO that month.
The new premium service will do a complete analysis of all IBD 100 stocks including industry rank, beta, sector ,ER information and technical analysis. After spending several months developing this product, I am looking forward to making it available to our group once the site construction is complete.
Alan
29 DaveP // Jan 21, 2010 at 10:23 am
Don, my bad for picking CTSH as an example. I had looked at the charts for the stocks on my watch list before I checked the ER dates.
Alan, just curious why the premium service would look at all IBD 100 stocks vs only those that are optionable?
Thx,
Dave
30 admin // Jan 21, 2010 at 1:14 pm
Dave,
The spreadsheet is set up to EXACTLY mirror the screening process as set up in my books and DVDs. When we scan the IBD 100, the first thing we check is whether that stock has options. The spreadsheet does the same (options available Y/N). If “No”, there is no further screening as we have been doing all along. This way we have precise continuity between the weekly screen and watch list and my books and DVDs. You will also be able to ascertain which screen kept a particular stock from “surviving” all screens.
Alan
31 Dave D // Jan 21, 2010 at 4:41 pm
Hi Alan,
Just running an exit stratergy by you…
RHB (Exit Strategy)
I bought this stock at $33.81… Then I sold an OTM option at the 35 strike to recieve 70c (ROO 2.1%, Upside potential 3.5%)…
Currently the stock price is $30.88 with the option value down to 20c (near to 20% of original value)…
Teachnical analysis of stock is mixed…(The main concern being the solid drop below EMA 20)
Market Tone, according to the SPX and VIX is positive (excluding thursdays market which was quite bearish)
As far as exit stratergies go, I feel I have 2 options here…
1) ROLL DOWN: Buy back the 35Call for 20c (I sold this for 70c) and sell the 30 Call for 1.70 (Profit =2.20)… If the stock remains above $30 on expiration date, this will be a loss of $1.61 (or $161 per contract).
2) TAKE NO IMMEDIATE ACTION: Buy back the 35 Call for 20c. Wait until the stock goes back up and then re-sell the option at the 35 Strike, hence, hit a double…
Another thing to take into consideration would be that its only the first week of what I think is a 5 week contract period.
So which action should I take? This seems to be the harder decision to make as fear and greed seem to be a little in the way. (I dont want to make a loss and yes, I want to make a profit)…
So Alan, in your opinion, which exit stratergy would be best suited here, and for what reasons?
Thankyou Alan for your time and wisdom.
Dave D
32 admin // Jan 21, 2010 at 6:15 pm
Dave,
You really broke this down beautifully. Exit strategy selection, like technical analysis, is oftentimes as much an art as it is a science. Rolling down, waiting to hit a double can both have cases made for them. One thing for sure, when you can buy back the option near 20% in the early stages of a contract cycle, we must act.
The market has been bearish (to say the least) of late and the tendancy is to think that it will keep going down. The opposite also applies and the truth is somewhere in the middle.
Although I am extremely conservative, I will usually look to hit a double in the earlier part of the contract cycle. If I see no positive action as I head to the mid-point of the cycle I may reconsider and look to roll down. If the stock continues to dcline and the market is stable, it may be time to convert dead money to cash profits.
Bottom line: I tend to be more aggressive with my exit strategies (recently with BCSI) , the earlier we are in the contract cycle.
Alan
33 GaryM // Jan 22, 2010 at 6:43 am
Alan, I for one am anxiously awaiting the premium website. While I like the exercise of doing my due diligence on the IBD stocks and the technical analysis I am also looking for some time saver aids and it sounds like your premi site will do just that. I for one have been out of the market and on the sidelines since December. I know you like to stay invested, but I am in the camp the market is going into a correction and will bide my time. Still reading your blog, learning, and honing my techniques while I get prepared to get back in the water. Thanks for your blogs.
34 admin // Jan 22, 2010 at 12:10 pm
Gary,
Your comments are much appreciated.
To the BCI community:
Although the charts of most equities have turned negative over the past week, I will continue to mention stocks that have caught my eye from a fundamental standpoint. From there, you may want to review the technicals, screens and calculations. One such stock is JDAS:
This company produced a positive 3rd quarter ER in late October causing the stock to hit a 52-week high. It is rapidly building up cash levels and approaching the level of zero debt.
As is usually the case, analysts have been raising earnings and growth projections as they jump onboard after the fact.
PE ratio is at a decent 19x forward earnings.
It has also held up quite well in the recent down market.
Keep an eye on this one. But watch out for the upcoming ER.
Alan
35 Dave D // Jan 22, 2010 at 2:37 pm
Gary M,
Just a few questions…
What makes you think we are going into a correction?
What indicators (if any), do you use to support this this belief?
Cheers mate
Dave D
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