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BLUE COLLAR INVESTOR Q&A- Your Questions Answered

This past Thursday and Saturday I conducted a webinar series attended by investors throughout the United States and Canada. I am humbled by the response and supportive emails that you sent during and after the presentations. Thank you. Investors had the opportunity to send questions during the course of the webinars and I felt that a few of them would benefit all readers of The Blue Collar Investor Blog:

1- Q- In this current economic environment, how are you handling your covered call strategy?

   A- Because of the unpredictable volatility of the market along with the lack of its orderly behavior, I have stopped selling options but continue to be fully invested in the market. My reasoning for maintaining my equity positions is twofold. First, in order to make up for recent losses, I feel that I need to be in an investment asset class that has the potential to do so. That rules out treasuries, CDs, money markets,       and the like. Historically, the market returns 11% per year and time and time again has proven to be resilient. Think back to the “crash” of 1987 and how the market recovered from that episode. Second, I refuse to believe that the market capitalization of the S&P 500 is now truly worth 40% less than it was just a few      months ago. Since all this selling has left a HUGE amount of cash on the sidelines, I feel that it is just a matter of time before all that liquidity sets a fire on the stock market.That being said, I should point out that things are so unusual and so few experts and investors have experienced this type of economic and psycholgical environment, that nobody really knows for sure how to proceed. That goes for Paulson,    Bernanke, Buffet, Cramer, me and anyone else you name. All we can do is take the path of common sense and adjust our decisions from there.

2- Q- Which online-discount broker should I use?

   A- There are many good ones out there. I can personally attest to USAA Brokerage Services. As an officer  in the military, I had access to all of USAA services, including the brokerage company. The commissions are extremely low ($5.95 per trade up to 1000 shares) and they provide reliable service. I suggest you do your own due diligence regarding the other companies taking into consideration reliable transactions,phone assistance, if needed, and most importantly, low commissions. Here is the contact information for USAA (non-military are now allowed to participate):

                www.USAA.com

                800-343-2250

                800-531-8722

3- Q- IBD suggests an 8% stop loss as a guide to selling a stock. What are your criteria?

   A- There is nothing wrong with setting a stop loss if you are long a stock. For me, 8% is a reasonable percentage in a normal market. In today’s volatile market, an 8% stop loss would result in a significant turnover in your portfolio several times a week. In a covered call position, you must first buy back the option to “free up” the stock for sale. You can enter a “limit order” to buy back the option at 10-15% of the original option sale. This, however, is not how I handle my stock/option positions. I will consider option buy-back when the option premium drops to 20-25 cents or 10% of the original option premium for the first 2-3 weeks of the contract preiod. I will buy back an option during the last week of the contract period only if I want to sell the underlying equity. I make my buy/sell decisions of the stock itself via technical analysis using moving averages (EMAs), MACD, Stochastics, and volume.Chapter 8 in my book, Cashing in on  Covered Calls, goes into great depth explaining this process. Those of you on my mailing list who would like a set of guidelines regarding these technical indicators, email me at alan@thebluecollarinvestor.com and I’ll be happy to send it to you for free. Use this as a general guide only, as technical analysis is more an art than a science.

4- Q- Why do you use 20 and 100 day exponential moving averages in your technical analysis rather than the 50 and 200 that most others use?

   A- I use the 20-d ema because we are selling 1-month options and there are approximately 20 trading days in month. I utilize the 100-d ema because my portfolio turns over 20-80% per month so these shorter term EMAs will serve as quicker indicators for our purposes. If I were a long term investor in stocks, without the options aspect, or sold longer term options, I too, would use the 50/200 indicators. Once again, I am using the path of common sense.

5- Q- How do we know when the market is settled enough so we can start cashing in on covered calls again?

   A- I am looking for an upturn in the housing and financial sectors as well as a loosening of credit requirements. Once this occurs, there is a strong likelihood that the institutional investors will start re-investing all that cash that is currently on the sidelines. One technical indicator I check is the VIX which is the Volatility Index that tracks the S&P 500. It is a measurement of market risk and is often referred to as the “investor fear gauge”. Values greater than 30 is indicative of investor fear and uncertainty while values under 20 infer calmer, less stressful times in the market. Needless to say, the current chart below is above 30 and approaching the planet Pluto! Use the ticker symbol $VIX to pull up the chart:

 

VIX Volatility Index as of 10-24-08

VIX Volatility Index as of 10-24-08

 

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Last Weeks Economic News:

Volatile stock Indexes reflected the continuing investor fear of a global recession. A few small positives were a slight rise in the Conference Board’s index of economic indicators, which measures the economy’s health. This was due to an increase in the money supply and consumer expectations. Also, existing-home sales rose 5.5% beating analysts’ expectations. For the week, the S&P 500 Index fell 6.8% for a year-to-date return of -39.2%.

Thanks to all who participated in the webinar series. I truly enjoyed spending the time with you.

Best regards to all,
Alan

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

6 Responses to “BLUE COLLAR INVESTOR Q&A- Your Questions Answered”

  1. Don October 26, 2008 2:23 pm #

    Alan, I have switched over to Treasury ETF’s. We can earn 20-25%
    annualized return with the safety of a Treasury. Try IEF. Like your web site. Don.

  2. admin October 26, 2008 3:43 pm #

    Don,

    This is an excellent conservative choice particularly in this market environment. For those readers not familiar with ETFs, they are mutual funds that behave and trade like stocks. IEF is a 7-10 year treasury bond fund that you CAN sell covered calls on. Here is Yahoo’s description of this fund:

    “The investment seeks results that correspond generally to the price and yield performance of the intermediate-term sector of the United States Treasury market as defined by the Lehman Brothers 7-10 Year U.S. Treasury index. The fund generally invests at least 90% of assets in the bonds of the underlying index and at least 95% of assets in U.S. government. It may also invest up to 10% of assets in U.S. government bonds not included in the underlying index. The fund also may invest up to 5% of assets in repurchase agreements collateralized by U.S. government obligations and in cash and cash equivalents”.

    The 1-year total return of the fund is 7.2% and oscillates in a conservative $10 range over a 52-week period. Since this is geared to a diversified bond fund, options returns will be in the 1-2% per month range.

    Those interested in screening ETFs try these two sites:

    http://www.etfscreen.com
    http://www.morningstar.com

    Thanks for sharing,
    Alan

  3. Barry Bergman October 27, 2008 9:02 am #

    Alan,

    Thank you for those ETF evaluation sites. Those sites will help us find strong ETF candidates. However, in staying with the foundation of the Blue Collar system…find the very best stocks in the world…I have a suggestion as to how we can extend that to ETFs.

    After finding appropriate ETF candidates on ETF Screen and Moringstar, we then can compare them to find those that are the “strongest” using their relative strength. By that I mean how they are performing relating to other ETFs and to their relevant index.

    The tool to do this is none other than StockCharts.com. There is a menu selection under the “Style” selection box called “PerfChart.” This chart allows you to compare the relative performance of up to 10 stocks or ETFs. In the ETF case, we then can choose an appropriate index ETF such as SPY or QQQQ for the benchmark and choose the ETF (s) you want to compare. The tool allows up to 10 different stocks or ETFs. In the case above with the Treasury ETF (IEF) we enter the SPY and IEF and then see the relative performance between them for the specified period. Once an ETF is chosen, then we use the other technical analysis tools in the Blue Collar system for subsequent decision making.

    Thanks for a great webinar,

    Barry Bergman

  4. Alan October 30, 2008 4:23 am #

    Barry,

    Thanks for sharing this valuable information.

    For those interested in utilizing a covered call strategy with ETFs should first make sure that a specific ETF is optionable. Type the ETF ticker into the option link of finance.yahoo. If an options chain comes up, you’re okay.

    Glad you liked the webinar.

    Alan

  5. Sara October 30, 2008 12:53 pm #

    Alan,

    One of the topics you covered in last week webinar series was exit strategies for expiration Friday. Could you go over the steps to follow once in your online broker’s account? I’m really anxious to get started!

    Thank you,
    Sara

  6. admin October 30, 2008 1:08 pm #

    Hi Sara,

    Sure will. As you know, the first step in all exit strategies is to buy back the option. Here are the steps to follow:

    1- From your online brokerage account, go to the options link.

    2- You will have the choice to “sell covered call” or “buy to close”. Choose the latter which means we are buying back the option to close our position. We still own the stock long.

    3- Type in or select the particular option you are buying back, the # of contracts, and the “limit”, not market price. Remember we sell @ the bid and buy at the ask (higher).

    4- Enter the order and you will be shown a screen to confirm the order. If it looks the way you expect, validate the order.

    5- Check the “order status” and once executed, go back to option screen to enter the next associated order.

    6- We now sell the covered call for the next month and proceed as above.

    7- Once this trade is executed enter the newly sold option into your portfolio manager list and the option profit into your options log.

    8- Now we monitor the newly sold option for potential next contract exit strategies.

    Remember to paper trade before getting started.You may also want to wait until the market trades on a more predictable track.

    Wishing you the best,
    Alan

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