Can you tell that I’m a baseball fan? I originally coined this phrase when I was teaching myself this strategy and then used it in my initial seminars. Most of my audience related to it and enjoyed hearing it so I kept it for my books and DVDs. When we “hit a double,” we buy back the option (buy-to-close) assuming it meets our 20%-10% guidelines, and simply watch the stock price without taking additional immediate action. Here, the goal is to wait for the underlying equity to appreciate in value in a relatively short period of time after the initial buy-back of the option, thereby driving up the option value. If this occurs, we can sell the exact same option (same strike and expiration date) and generate a second income stream from the same option, or, in other words, “hit a double.” Over the years, I have actually also hit a few “triples,” wherein the same option was sold three times prior to its expiration!
As s rule of thumb, we attempt to “hit a double” when the market tone and stock technicals are mixed to positive earlier in the contract period (especially during the first week or early in the second).
Real-life example of “hitting a double:”
The chart below depicts an actual example of when I “hit a double” with respect to a prior covered call position in Blue Coat Systems, Inc (BCSI), which ultimately generated an additional $868 into my account. Bear in mind that the additional $868 does NOT include the original $992 I “earned” when I sold the option for the first time. First, let’s look at the chart for BCSI as it existed at the time this exit strategy was implemented:
Hitting a double with BCSI
Note how BCSI took a big plunge (blue arrow) and then recovered quickly over the next two weeks (red arrow). Here are the four prongs of this one-month investment:
- 10/26/09- Purchased 1000 shares of BCSI @ $25.35
- 10/26/09 – Immediately sold 10 contracts of the slightly in-the-money November $25 call option for $1.35, generating a profit of $992 (I deducted the intrinsic value of $0.35, as well as commission, in calculating the latter $992 figure). Should I be happy and complacent and head for the mall? Not Blue Collar Investors!
- 10/30/09 – Took advantage of a market dip and bought back the 10 contracts for $0.25 per contract ($250 in total) in accordance with our 20% guideline, thereby creating a loss of $262, inclusive of commissions.
- 11/5/09 – Took advantage of a price upswing (red arrow) and re-sold the EXACT SAME 10 OPTIONS for $1.15. This generated an additional $1130 into my account, inclusive of commissions. Thus, my net gain in connection with the utilizing the “hitting a double” exit strategy in this example is $868 ($1130 – $262). It took me less than 5 minutes to buy back the option, and less than 5 minutes to re-sell the option a few days later. Now, if that doesn’t put a smile on your face, let’s add in the initial option profit of $992, for a total profit of $1860 ($992 + $868). Our original investment was $25,000 using the intrinsic value of the first option premium to “buy down” the cost of the stock from $25.35 to $25 (use the Ellman Calculator if this part troubles you). As such, our one-month profit or ROO is: $1860/$25,000 = 7.4%, one-month return. So now it’s time to head to the mall, right? Nope, still two more weeks until expiration Friday!
Conclusion:
As demonstrated in the above-referenced example, the “hitting a double” exit strategy is best utilized when the underlying equity, and thus, the option premium, will appreciate in value in a relatively short period of time. If, however, the price of the underlying equity does not appreciate in this manner, we can then look to roll down, or alternatively, to possibly implement our third exit strategy, which involves selling the stock and “converting dead money to cash profits.”
Radio interview:
I have been invited to be a guest on the Unlock Your Wealth Radio Program. I will post the pertinent information once I have the date and time firmed up with the show’s producer.
New file added to premium site:
The BCI team has created a brief outline of the Greeks and their impact on our option premiums. We have also listed some of the factors that impact each of these parameters and the direction and impact they have on our options. Look in the “resources/downloads” section of the premium site and the heading “Greeks- Summary”.
Premium report video:
It has been almost a year since the BCI team produced the first premium report. Over the past year we have added new features to enhance the quality of the report to an even higher level. Thanks to our members for making comments and suggestions that led to these some of these enhancements. I have produced a new video that describes the incredible amount of information found in these reports. The video will be incorporated into this site in the near future. Here is a link to an early view of the enhanced premium report:
http://www.youtube.com/watch?v=e7pYtlTyYgU
Rolling video on home page:
As we approach the final week for the March contracts, I have highlighted the rolling exit strategy video on our homepage for those in need of review.
Market tone:
Recent global issues have created enhanced market volatility, not a friend of conservative covered call writers. Friday’s market appreciation was minimized in significance because of the low trading volume. For the week, the economic reports continue to be favorable overall:
- The big negative for the week was the huge jump of 15.1% in the trade deficit, bringing it to the highest level in 7 months
- Retail sales rose by 1.0% in February, the best growth since October
- December and January retail sales were revised upward
- Business inventories rose for the 13th consecutive month in January by 0.9% reaffirming the economic recovery
- Consumers increased their borrowing by $5B in January reflective of more confidence in the economy
For the week, the S&P 500 declined by 1.3% for a year-to-date return of 4.1% including dividends.
A major force behind a stock’s performance is the general market conditions or tone as I reference it on this site. Over the past year the S&P 500 technicals as well as the CBOE Volatility Index (VIX) have reflected bullish patterns and the market has responded accordingly. More recent evaluations of these chart patterns are trending SLIGHTLY bearish. This will not dissuade me from investing in the market but will encourage me to opt for the protection of I-T-M strikes. I have created 3 charts for your review:
1- Chart I is a 1-year comparison chart showing an uptrending S&P 500 and a calming VIX, a bullish combination.
2- Chart II is a 6-month chart showing an uptrending S&P 500 with a flat VIX, still bullish but less so.
3- Chart III is a 1-month chart showing an accelerating VIX with a slightly declining S&P 500, a bearish combination.
Here are those charts:
1-year comparison chart
6-month comparison chart
1-month comparison chart
Summary:
IBD: Market in correction
BCI: Cautiously bullish selling predominantly I-T-M strikes until the volatility subsides.
My best to all,
Premium Members,
The Weekly Premium Report has been uploaded. Look for the report for the week ending 03-11-11.
Best,
Barry
Alan,
Can you explain “buy down the cost of the stock from $25.35 to $25″.
Thanks.
Joe
Alan,
Thanks for the new video about the premium report. There is a lot more information there than I realized. Keep up the good work.
Larry
Joe (#2),
In the example given in this week’s article BCSI was purchased for $25.35 and the $25 call was sold for $1.35. If exercised, we will incur a loss of $0.35 per share decreasing our profit to $1 per share or $100 per contract. If we use $1.35 as profit we would be incorrectly inflating our profit and percentage return.
That being said, we do, in fact, receive $1.35 per share so if we aren’t counting the $0.35 as profit, what happens to it? In my system and inherent in the Ellman Calculator we always deduct the intrinsic value of an in-the-money strike from the share price bringing down our cost basis to the strike sold, in this case $25. Calculations would be as follows:
ROO = $1.35 – $0.35/$25.35 – $0.35 or
$1/$25 = 4%, 1-month return
We also have a small amount of downside protection:
$0.35/$$25.35 = 1.4%
Those members who are new to covered call writing and the BCI system may find this a bit confusing at first but will make sense as you run more and more calculations. Again, all these formulas are inherent in the Ellman Calculator.
Alan
Hi Alan–
In your reply to Joe, you create a senario where you purchase a stock for 25.35 and sell the 25 call for 1.35. The 1.35 premium consists of .35 intrinsic and 1.00 TV. I agree that the yield, if exercised, will be TV/ out of pocket cost of the stock transaction.
Thus, I used to calculate my yield as 1/( 25.35 – 1.35). I actually had to come up with 24.00 at the time of the buy-write or complete transaction. My yield would be 1/24.00 = 4.2%
Not much of a difference but it grows as you write deeper in the money and thus spend less to perform the transaction.
I think I have asked this before, and apparently am still confused.
Mike
Mike,
The difference between the two calculations is a philosophical one. There are other cc calculators that will calculate results the way you suggest. They are not wrong but I feel that the BCI approach is easier to understand and promotes higher returns. The question is how do we compute the $1 of time value. In the scenario you present, you are using it both as profit AND to further lower the cost basis. If the position was closed and completed, I could go along with that. However, in the BCI system we stress (big time) compounding our money. Therefore, that $100 per contract and all the other option premiums generated that month are pooled and used to buy additional equities and then we sell calls on those profits. We are “compounding our money in minutes”. In one approach we are using the time value to lower our cost basis and in the other (BCI) we are using it to generate additional income. You are spot on when you say that the magnitude of the difference is minimal but could add up over the years but it will be compensated for and then some with the additional income generated from re-investing your money. Whichever approach you decide to use, as long as there is a full understanding as to how these option profits are benefiting our portfolios, we can properly analyze our results.
Great question.
Alan
Hello Mike,
I agree with your approach to yield calculation. I do the same thing. I think Alan is just very conservative is his upside claims. It goes with his style of being conservative across the board and understated. I find him so refreshing not selling in our face, Motley Fool, or making exaggerated claims. By the way I enjoy purchasing his products not being sold.
Could anyone tell me why one of my stocks would have been exercised for the dividend ? Why would someone purchase the option and stock as opposed to just buying the stock with only one commission? I am very conservative so this a curve I’ll have to learn to hit. I invest many ITM and with an eye toward the div as a part of total return.
Thanks to anyone who answers, we have a great community here. Phil from MA.
Question – I own AVGO sold covered call. When iut dropped I bought back the calls for 15c. Now the stock has not recovered and it’s off the white list. What do I do with it now – at least according to the system? I’m fairly new and trying to get this right. Love the web site and the advice.
Oh yeah – bought the stock at $33.80 – it’s at $31.24
Frank,
With 1-week remaining until expiration of the March contracts there is little or no time value associated with the premiums. So the question remains, do I want to keep this stock and risk further depreciation or stay with it because you still have confidence in it. Many stocks have moved out of the “white” areas of our running list due to market volatility lately. This is still a great performing company although a bit weak in the past few weeks since the ER. Looking at a very recent 2-d chart and this stock and comparing it to the general market, we see that it appears to be strengthening although this is a small sample. I would have been more likely to sell it had it underformed the market lately. Check out the recent 2-d chart below:
Alan
I have been with BCI a couple of weeks. I have been scanning the archives of the past three months and have noticed there are a lot of members that are skilled in this CC writing. If one uses the BCI approach ,the way Alan has set it up, and does not veer from it, what can we expect in terms of success/failure. I am looking for ball park percentages. For example, base it on every ten trades. Also, what is your average profit /loss under the same conditions? I am enjoying being a member of the BCI and feel the blogs are very worthwhile.
Bill
Alan,
In this week’s premium report it looks like many of the stocks are scheduled for earnings in the May contracts. Have you found it difficult to fill your portfolio on these months when earnings come out?
Thanks.
Larry
Larry,
Earnings season is always a bit of a challenge but there are ways to navigate around this issue. Here is a link to an article I published that addresses this concern:
http://www.thebluecollarinvestor.com/blog/locating-covered-call-candidates-during-earnings-season/
Alan
Any comments on how the tragedy in Japan will effect our CC sales? With the market down this morning and the end of the month so near – shall we wait and see what happens or sell some CCs for April. I have some cash at this point so I’m trying to decide what to do.
Frank,
With the current market volatility I am holding off on commiting new cash. Once things settle, I’m back in. Just my 2 cents.
Barbara
Frank,
Most covered call writers are conservative investors. Volatility in the markets is not a friend and so, like Barbara, most would opt to hold off on investing more cash until the market calms. More aggressive investors may try market timing by purchasing stocks on a market downturn and wait to sell the option when the market recovers. This is not my style but I know we have members who like this approach. Once again, it’s a matter of risk tolerance.
Alan
For the last 5 months my results have shown that I would have been better off just buying and holding the stock for the month, rather than selling covered calls. Is this common, or am I doing something wrong?
Bill,
I have been following the BCI system for 2 years and have been quite pleased with my results. I don’t have percentages but I can say the winners far outweigh the losers and a lot depends on the market conditions. I have also improved my results as I started using more of the exit strategies.
Best of luck.
Jorge
Does anybody here buy leap options instead of the stock to sell covered calls? It seems like you can make the same profit but have a lower cost basis.
Tim
Dave (#17),
There are certain rare market conditions when pure stock ownership will outperform covered call writing. This is when the market is growing exponentially and I discuss it on page 4 of “Cashing in on Covered Calls”. The reason is the fact that we are capping our profits with the short call. However, in normal market conditions where the market is appreciating between 1/2% and 1% per month, covered call writing will return superior results and provide downside protection should the market turn bearish. One thing you may want to look at is strike selection. If the market is bullish as it has been (until the past several weeks when global issues have impacted the stock market) we utilize out-of-the-money strikes which will generate BOTH option premium and share appreciation (if, in fact, the stock does go up in value).
Alan
Tim (#19),
We do have a few members who use long LEAPS positions instead of stock ownership to protect their short call positions. This is NOT true covered call writing and has a few drawbacks that you should be aware of before adapting this strategy. Once you have evaluated all the pros and cons you can decide if this strategy is right for you. Here is a link to an article I published on this topic:
http://www.thebluecollarinvestor.com/blog/covered-calls-and-leaps-an-alternative-strategy/
Alan
Tim,
I tried this approach a few years ago and got burnt with stocks that dropped after earnings were reported. I’m back to one month options. Hope this helps.
Brian
A bit late, but I thought I would offer a response to Mike’s #5 post about calculating the return. Alan and I discussed the method of calculating the return at great length when I was creating the calculator.We settled on the more conservative method for a number of reasons.
We preferred to be more on the conservative side in order to keep the percentages from becoming the priority, rather than the safety and wisdom of the actual trade.
Using the method we did also makes it easier to compare various trades, regardless of in-the-money, out-of-the-money, or at-the-money.
My main defense of our method is that you are actually investing $25, not $24. My analogy is this. You bet $1,000 on red on the roulette wheel and win. You now have $2,000. When you place the next bet, are you betting your money, or someone else’s?
In the example where you buy a for $25.35 and sell the $25 call for $1.35, we reduce the $0.35 from both sides simply because it is, essentially, a refund of part of your purchase price. Or, you could look at it as an advance payment on the sale of the stock. The remaining $1 is yours, now. You can use it to buy stock, bonds, a boat, whatever. It’s your money. You have still spent $25 for the stock. It doesn’t matter if you think you used money you previously had in the account, or you used your “winnings” from the option to buy part of the stock. You still paid $25 for the stock from your account.
Anyway, Mike, I hope this helps explain why Alan and I chose the calculation method we did.
Hi Alan, question concerning “option volume”
on a weekly search stock. This week’s only stock that passed (VPHM) has such low ” April Open Interest”, are we wasting our time at any further consideration for a CC? Appreciate your feedback.
Duane,
More important than volume which is a daily stat is open interest which is cumulative. The OI for the April contracts we are most likely to consider are 120 and 182 with each contract representing 100 shares. I also look at the bid-ask spreads and both appear to be reasonably placed (not dramatically far apart). Below is an options chain that reflects this OI and B-A spread. I would NOT eliminate this stock from consideration at this time.
Alan
Duane (#24),
My thoughts are along Alan’s lines. The issue I usually look at is the overall liquidity of the option. That typically is represented in the bid-ask spread. Although I like to see at least 250 contracts OI, I’ll look at a stock with at least 100 contracts OI and a reasonable spread. In this case, for the $20 strike, you probably “negotiate” the spread…shooting for the mid-point of the spread.
Barry
Duane,
I see that the OI for the March contracts is much higher. I would expect the OI for thye April contracts to increase after these March contracts expire.
Fred
Radio interview:
A radio interview I previously participated in is being replayed today. Here is the link:
http://www.thebusinessauthorsshow.com/
Alan
Allan,
I’m reading your book on exit strategies. On page 45 you talk about rolling out and up to an in the money option. Can you explain how you can roll up to a strike that’s in the money as you bought the stock for 78 and are now selling the 85 option. Your help is appreciated.
Liz (love both books!)
Liz,
In the example on page 45 the stock is trading @ $86 near expiration Friday. Having originally sold the $80 call, selling the next month $85 is rolling out (next month ) and up ($80 to $85). It IS an in-the-money strike in relation to the CURRENT market value of $86 by $1 which gives us a small amount of downside protection of the premium’s time value.
Thanks for your comment about my books.
Alan
Can anyone recommend a site for analyst buy-sell-hold information.
Thanks
Joe
Joe,
You can get analyst opinion from the yahoo site:
http://finance.yahoo.com/
Type ticker-get quote-analyst opinion.
Good luck.
Barbara
Joe,
Here is an excellent site that Alan once recommended:
http://www.finviz.com/
Amy
AGP:
Many of the stocks on our premium watch list moved to the “pink” cells because they didn’t meet our strict technical requirements. This was mainly a result of general market forces resulting from global issues (Libya, Japan and others). AGP is one such equity but once the market calms many of these stocks will return to the “white” cells.
On February 18th AGP boasted a 42% earnings surprise. Revenue was up 10% with cash @ $764M abd debt @ $246. Analysts have been raising guidance as a result. AGP trades at a reasonable 15x forward earnings. If we set up a chart as described in figure 28, page 85 of “Cashing in on Covered Calls”, we see that this stock still trades above its 20-d ema but the momentum indicators have turned negative once again due to overall market forces. Its worth keeping an eye on this equity.
Alan
Premium members:
This week’s report of top-performing ETFs has been uploaded to your premium site. New members: if you didn’t receive a direct email notifying you of this upload, please let us know and we’ll add your name to the premium mailing list. Premium members, who have changed their email addresses and do not receive direct emails, send your updated address to:
info@thebluecollarinvestor.com
For your convenience, here is the link to login to the premium site:
http://www.thebluecollarinvestor.com/member/login.php
Alan and the BCI team