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How To Negotiate Better Option Prices Using The “Show Or Fill Rule” / $30 Rebate Expiring

Covered call writers generate cash flow by selling call options associated with a stock or exchange-traded fund. Our goals are to generate the highest possible returns with low-risk trades and that fit our requirement for capital preservation. The three required skills for achieving these goals are stock (or ETF) selection, option selection and position management (exit strategies). In this article, I will discuss a fourth, less apparent skill, negotiating a better price with the market-maker.

Market-makers generate profits from the bid-ask spreads…the greater the spread the more money they make. From their perspective, they want to buy as low as possible and sell as high as possible. To protect retail investors from large spreads, the SEC has established the Show or Fill Rule also known as the Limit Order Display Rule or technically the Exchange Act Rule 11 Ac1-4. This regulation requires market-makers to show or publish any order that improves the current “bid” or “ask” prices unless it is filled. Any order between the bid and the ask will improve the market.

When the spread is small, say $2.50 – $2.60, we don’t have that much to work with. But what if the spread was $2.50 – $3.00? If we placed a market order, we would most likely get filled at the bid price of $2.50 and there may have been an opportunity lost. Instead, let’s leverage the Show or Fill Rule: Find the mark or mid-point of the bid-ask spread and drop down slightly in favor of the market-maker and place a limit order at that price. In this case, the mark is $2.75. I would place a limit order to sell the call option at $2.70, not $2.50. Now the market-maker is faced with a dilemma…execute our trade for $2.70 or publish the new spread at $2.50 – $2.70. The $0.50 spread now becomes a $0.20 spread. It is now in the hands of the market-maker. In many cases, we will get executed at $2.70 and the published spread will remain at $0.50 as we pocket an additional $20.00 per contract. Covered call writers are in the business of selling options. These $20.00 “bonuses” will add up over an investment lifetime.

Real-life example as of market close 4-17-15

Negotiating better option prices for covered call writing and selling cash-secured puts

Bid-ask spread for AKRX

 

  • Spread: $2.00 – $2.35
  • Mark: $2.17.50
  • Place limit order to sell covered call at $2.15

 

One more thing: Our trade execution forms have an All or None (AON) box. Do not check this box. If we do, the market-maker is no longer obligated by the Show or Fill Rule.

Enjoy the extra cash!

 

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The BCI team and our members…a total team effort

 

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We are offering this deep discount ($125 – $30 = $95) for early-ordering of our newly-released DVD Program which details all aspects of Put-Selling including stock selection, option selection and position management. The Companion Workbook contains 50 all-color pages of all charts, graphs and slides. You will also get a BONUS DVD of the 10 Most Costly Mistakes Made by Put-Sellers and how to avoid them. Here is a link to the course outline:

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6:15 – 8 PM

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Market tone

US economic data stabilized, adding to speculation that the Fed could raise rates in September. Fed policymakers indicated the pace of further rate hikes could be slowed after this year, and US stock indices rose in response to this less aggressive stance. The Greek government appeared no closer to a deal that would help avoid a potential default on repayments due to the International Monetary Fund at the end of June, raising the risk that Greece could exit the Eurozone.  This week’s economic reports:

  • The US Federal Reserve still expects to begin increasing interest rates this year with the benchmark short-term interest rate expected to remain below 3% through December, 2017
  • US housing starts fell 11.1% in May to a seasonally adjusted annual pace of 1.04 million units
  • However, permits for future home construction rose 11.8% to 1.28 million units per year, the highest since August 2007
  • The National Association of Home Builders/Wells Fargo builder sentiment index climbed to 59 from 54 in May, another indication of growing strength in the housing industry
  • US consumer prices rose 0.4% in May, the most in two years, caused mainly by a 10.4% increase in gasoline prices
  • Overall prices were unchanged from a year earlier, while core prices rose 1.7%
  • Initial jobless claims fell 12,000 to 267,000 for the week ended June 13th, the fifteenth straight week below 300,000
  • Continuing claims declined 50,000 to 2.2 million for the week ending June 6th
  • The Conference Board’s index of US leading economic indicators rose 0.7% in May, better than expected

For the week, the S&P 500 rose by 0.76% for a year-to-date return of 2.48%.

Summary

IBD: Confirmed uptrend

GMI: 5/6- Buy signal since market close of May 11, 2015

BCI: Cautiously bullish but concerned over situation with Greece and how the markets respond. Next week should create more color on this issue. In the interim, I am selling an equal number of in-the-money and out-of-the-money strikes but expect to get more aggressive once this matter is resolved.

Wishing you the best in investing,

Alan (alan@thebluecollarinvestor.com)

 

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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.

33 Responses to “How To Negotiate Better Option Prices Using The “Show Or Fill Rule” / $30 Rebate Expiring”

  1. Jay June 21, 2015 11:48 am #

    Dear Alan,
    Of the many option selling skills you have taught me arguing with the market makers is the best :). I have learned to let them come to me. I always set my limits above the mark and most of the time they fill. If not, no big deal, at least I did not get filled at a discount for my broker!

    What goes up must come down. Our ASHR took it on the chin last week. I consider it a growth investment so I do not sell calls against it hoping growth will out pace income. Probably would have been better this month if I did – one never knows :). – Jay

  2. Keith June 21, 2015 11:55 am #

    Alan,

    How do I calculate as of today, the US stock market’s performance, such as up xxx %?

    Keith

  3. Roni June 21, 2015 4:04 pm #

    Dear Alan,
    This is one of the best advices from you books.
    Since I read your book in late 2013, I have always used this method in all my trades, and the result is exactly as you described.

    As I diversify a lot, I do an average of 50 trades per month, and save anywhere from $10.00 to $50.00 or more on a trade.
    So, this advice must have saved me more than $10,000.00 since I started.

    Thank you Alan for this, and for all the other great ideas you shared with us.

    Roni

  4. Alan Ellman June 21, 2015 4:54 pm #

    Jay and Roni,

    I appreciate the positive feedback. I hope many more of our members have followed in your footsteps. These small “bonuses” do add up significantly over the years.

    Alan

  5. Barry B June 21, 2015 9:24 pm #

    Premium Members,

    This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor premium member site and is available for download in the “Reports” section. Look for the report dated 06/19/15.

    For your convenience, here is the link to login to the premium site:

    http://www.thebluecollarinvestor.com/member/login.php

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:

    http://www.youtube.com/user/BlueCollarInvestor

    Best,

    Barry and The BCI Team

  6. Alan Ellman June 22, 2015 7:02 am #

    Running list stocks in the news: GIII:

    G-III Apparel seems to be taking over the apparel industry. Its brands include Karl Lagerfeld, Calvin Klein, Tommy Hilfiger, Levi’s, Dockers and many more. It has licenses with the NBA, NFL, MLB and NHL along with over 100 colleges and universities.

    On June 2nd, GIII reported a stellar 1st quarter earnings report with earnings more than doubling consensus and sales up 18% year-over-year. Same store sales were up 17% compared to the same quarter a year ago. As a result, the company along with all analysts raised guidance with earnings expected to grow 21.5% in 2016 and 16.4% in 2017.

    Our most recent Premium Watch List shows GIII in the apparel industry with a rank of “A”, a Stock Scouter rating of “7”, a beta of 1.15, adequate open interest for near-the-money strikes and a projected next earnings date of 9/2/2015.

    Alan

  7. Michael June 22, 2015 7:29 am #

    Just a quick question, not a crises or quick response necessary, just when you have time.

    I have an old IRA account that has not been used in many years, honestly I had forgotten I had it. It is not a very big account, at about $3800 last time I looked.

    My question is: will your strategies work for a small account? Hopefully it will get larger. If it would I don’t see any reason I would not subscribe, after checking out all the junk out there, you folks seem the most realistic.

    Thanks for your response.

    Michael

    • Alan Ellman June 22, 2015 7:41 am #

      Michael,

      Your interest in taking control of your financial future is a great way to start however it may be a bit premature to subscribe to our Premium Membership.

      One of the key requirements for option-selling is to be properly diversified in the underlying securities. This means either a minimum of 5 stocks in 5 different industries or using exchange-traded funds (I use these in my mom’s account). For ETFs I would say a minimum of $15k is a good place to start.

      That said, you have fabulous opportunities right now. First, start the learning process today while your portfolio value continues to grow. When you’re ready to sell options, you will have mastered the strategy and then have years and decades to benefit.

      Consider building your wealth in the stock market via low-expense ratio, broad market index funds. I discuss this wealth-building approach in my book, “Stock Investing for Students”

      http://www.thebluecollarinvestor.com/stock-investing-for-students/

      Education while building wealth…the future looks bright.

      Alan

  8. Keith June 22, 2015 7:44 am #

    Alan,

    The S&P 500 is up 2.48% YTD. My YTD return on investment is 7.69%. What do you think I am doing, such as scale 1-10 for all traders’ performance, which scale I am at ? I really don’t have any idea.

    keith

    • Alan Ellman June 22, 2015 7:47 am #

      Keith,

      I think Goldman Sachs is out looking for you right now. You’re tripling the performance of the overall market. I give you a “10”

      Keep up the good work.

      Alan

      • Nate June 22, 2015 3:28 pm #

        Good Job Keith! Over the years I read and heard countless times that very few people can beat the market long term. That it is just too hard to do or maintain. I’d say that in the BCI community that it is quite the opposite and that very few don’t beat the market. :) You are probably in the top 5% in the world. Congrats!

      • Keith June 22, 2015 4:44 pm #

        Dear Alan,

        Really? Then I should prepare my resume then :) I must say it is purely under your guidance. Before I do the trade with your methodology, I have no idea what is trade and gave everything to 401K broker, and they lost big portions of my fund.

        Thanks again Alan!

        The way I calculate my ROE is to find the balance as of Jan 1, 2015 (A), then I take the live account value as of today (B), then (B-A)/A * 100%. Right way to calculate?

        keith

        • Alan Ellman June 22, 2015 4:46 pm #

          Keith,

          You also get a “10” in math.

          Alan

  9. Tony June 22, 2015 4:55 pm #

    Hi Alan,

    Here’s some new research that it is a real GAME CHANGER that I think will make us more money.

    When we sell a Covered Call, we are playing TWO games.

    The profit we make is equal to the sum of the increase in underlying price + Call premiums over time.

    We win game 1 (underlying going up) by choosing stocks with good fundamentals and technicals – by using the Blue Collar Investor.

    We still MUST win game 2 (selling calls to make a bigger profit over time).
    If at expiry, the call ends up ITM, we have to pay back a certain amount to keep owning the share (and we lose Game 2).
    If it ends up OTM, we win Game 2
    If we don’t manage our positions then over time Option Premium prices have been designed so we end up with a net of $0 selling Calls every month.
    In actual fact Implied Volatility (used to calculate option premium price) is lower than Actual Volatility, we statistically should end up with a small net gain.

    In order that Game 2 is not zero sum, I think the way we IMPROVE the odds is by taking profits EARLY (before expiry). A 0.3 delta roughly means a 30% chance of making a loss on game 2 AT EXPIRY, but if we close out BEFORE EXPIRY, we can stop the game, take our profits and re-start the game, with the same 0.3 odds.
    Statistically, we can make more money this way.

    The study I’m referring to, took the SPX between 2004 and 2014, and consistently sold a Call on this. They looked at the final profit/loss and compared using selling a very wide range of deltas, a wide range of Days to Expiry (DTE) and for each strike, they compared a wide range of Take Profit.

    Curious to know what they found? The optimal profits were reached when you sell options with 45 DTE with a delta of 0.47 and take profits at 40%.

    What do you think?

    Tony

    • Alan Ellman June 22, 2015 5:28 pm #

      Tony,

      I would never accept or reject a strategy without testing it over and extended time frame to see how it performs in the real world of practical trading. So my ultimate response is “I don’t know” This is a tough one to evaluate because there is probably some missing information. Does it apply only to SPX? If not, how are underlyings selected? What about position management…only a mention of closing positions.

      That said, I would strongly urge you to research these concerns before implementing this strategy in conjunction with BCI:

      1- I view the concern with covered call writing to be the underlying stock, not the option. The premise here is the reverse. We “win” if share price goes up, stays the same or declines by less than the option premium. The risk is in the stock.

      2- We’re playing two games…true for out-of-the-money strikes only. No share appreciation for at-the-money or in-the-money strikes.

      3- “If strike is ITM, we are losing money” I’d debate that one as well. Unless there is a gun to our head, we can allow assignment…take no action and our shares are sold at the strike and we have maxed our trade. The cash can be used to enter a new position after expiration…a happy outcome. Now, if we decide to buy back the option at expiration, it would be to “roll” the option to the next contract. This implies an option credit, not a loss. In addition, if the option is closed near expiration, we are paying intrinsic value as the option will be trading near parity…almost a wash as option debit will equal share credit.

      4- Take profits at 40%. How many positions are we managing to be closing at all different time frames…theta differs from one security to another. This is not an issue if only using SPX. Closing also implies paying more time value to close as theta is logarithmic in nature for near-the-money strikes.

      5- Use options with deltas of 0.47. I would really scrutinize this one. We are talking about at-the-money (or near-the-money) strikes only. If that is truly a part of this strategy there will be huge opportunities lost. Bear markets demand in-the-money strikes and strong bull markets favor out-of-the-money strikes. Here one size fits all if we have all the information. Also, if we are using only near-the-money strikes, aren’t we down to only one “game”…option profit?

      6- 45 days to expiration…are we limiting our underlying choices only to securities that are part of the expanded weekly options program?

      I am not criticizing or rejecting this strategy for the reason I gave initially. I am saying that there is much to research before embracing it.

      Alan

  10. Nate June 22, 2015 6:35 pm #

    Between the “show or fill rule” and choosing a low commission discount broker there is much to be saved and not taken out of our pockets.

    Here’s an article Allen posted a while back on commissions: http://www.thebluecollarinvestor.com/evaluating-brokerages-and-comparing-their-commissions/

    I recently did a comparison of two brokers I use. After an average of 10 trades a month. Which really turns out to be about 30 transactions for me. 10 to enter, 10 to sell options, 10 to exit.
    It costs me about $250 in commissions for the month in one account ($8 for shares, $8+.75 per option). In another account it costs about $130 ($4 for shares, $5 for options). Just by switching to my lower commission account I am saving about $120 (250-130) a month. $1440 a year. Add that up over the years and I get to compound that money for a lifetime which otherwise would have been the brokers money to compound.

    I encourage you guys to do your own calculations and see which works best for you and your goals.

  11. Celia June 24, 2015 9:59 am #

    Dear Alan,

    I have been following your strategy and trading live for 1 month now. I initially found your videos on YouTube, and then I watched the covered call video lessons and then read your book “Complete Encyclopedia for Covered Call Writing”. I have had trading experiences in other markets but your method has completely opened my eyes for the option markets and I have decided to follow and trade your method. I would like to say a big thank you for all the efforts you put in to help retail investors and how clearly you have explained your strategy. I am so glad that I have found you.

    Overall according to my broker’s report my cumulative return is 3.78% from May 19th to June 19th. I gradually added the funds into my trading account so the return percentage would be based on the amount of funds I had at the time of trading. I would not be able to earn any profits without the help of your premium report, elite calculator, your books and all your videos and information. Thank you again Alan and your team!

    Regards,
    Celia

    • Alan Ellman June 24, 2015 5:52 pm #

      Celia,

      Congratulations and thanks for sharing the good news.

      Continued success,
      Alan

  12. Alan Ellman June 24, 2015 5:50 pm #

    Premium members:

    This week’s 6-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site. The report also lists Top-performing ETFs with Weekly options.

    For your convenience, here is the link to login to the premium site:

    http://www.thebluecollarinvestor.com/member/login.php

    NOT A PREMIUM MEMBER? Check out this link:

    http://www.thebluecollarinvestor.com/membership.shtml

    Alan and the BCI team

  13. Alan Ellman June 24, 2015 5:51 pm #

    Thanks to one and all for your incredible support and generous feedback for our new put-selling DVD Program…more product announcements in the next few months.

    Alan

  14. Toan June 25, 2015 7:35 am #

    Hi Alan,

    I reviewed your 8 video lessons and I did not hear you mentioning to the purchasing a long LEAP put for downside protection for 24 months during the selling call .
    The example from your lesson number #7 :
    If the stock market is dropping 50%; then what should we do to protect our investment as in this case .
    Please advise and provide a strategy for study.

    Appreciated,
    Toan

    • Alan Ellman June 25, 2015 7:46 am #

      Toan,

      One of the main focuses of the BCI methodology is to protect against share decline and preserve capital. The Beginners Corner series you are alluding to are overviews of the two option-selling strategies. Position management is addressed in great detail in my books/DVDs. For example, see pages 245 through 302 in the “Complete Encyclopedia for Covered Call Writing” In our full DVD Program, one full seminar is devoted to this topic. Here is an overview of how we can manage bear markets scenarios and even catastrophic aberrations implied in your question:

      Sell in-the-money strikes
      Use low-beta stocks
      Use more conservative ETFs instead of more volatile stocks
      Buy protective puts (your suggestion)
      Sell out-of-the-money puts to enter a covered call position “at a discount”
      Use inverse exchange-traded funds (extreme bear markets)

      It is critical we all master position management before entering any option-selling trade. That’s why your question is an important one.

      Alan

  15. Anton June 26, 2015 5:08 am #

    Alan

    Sometimes share prices make big moves intraday, surely for a reason, but many times I am not able to find any related news (eg NHTC -4.75%). Are you aware of any internet source that provides this information?

    Thanks,
    Anton

    • Alan Ellman June 26, 2015 7:28 am #

      Anton,

      This stock got a boost this week due to its inclusion in the Russell 3000 index. Yesterday it dropped $2.10 on higher-than-average volume with no apparent news. It could be simply profit-taking as the stock is still up about $3 from its Monday open.

      A great resource for stock news is:

      http://www.finviz.com

      Another site:

      http://www.seekingalpha.com frequently gives additional color to the news but is opinion-based so be careful to evaluate from this latter site.

      Alan

  16. Frank June 26, 2015 10:10 am #

    Alan,

    A few questions:

    1. Can I do Covered Call Writing in my Roth IRA account?
    2. Can I somehow get connected with BCI investors using Scottrade?

    Thanks. I’m very new at this, but am very interested and hopeful to try it. Just seems like I need a lot more education.

    Frank

    • Alan Ellman June 26, 2015 10:21 am #

      Frank,

      Welcome to the BCI community! My responses:

      1- Yes, covered call writing is the one option strategy that is universally accepted by brokerages to be appropriate in sheltered accounts. Whenever possible we should favor these accounts because of all the short-term capital gains we are realizing. Your broker will require you to fill out a form explaining your experience with stocks and additional financial information. This strategy requires the lowest level of trading approval.

      2- You can post your contact information on this blog or request that members send their contact information to me and I’ll pass it on to you. The education is our primary focus when starting and then paper-trading. See if your broker offers a paper trade platform. If not, there is one on the CBOE site:

      http://www.cboe.com/tradtool/papertrademain.aspx

      While this learning process is proceeding, familiarize yourself with the broker platform as it relates to covered call writing. Have a specialist walk you through the process if need be.

      Let us know how you’re progressing.

      Alan

  17. Nate June 26, 2015 12:14 pm #

    What’s your take on ASHR? This is my first big drop since using the system. I bought back the option in the first week at about 8% the original sale. It seems like many are panicking about a “bubble”. I on the other hand am not panicking, it hit my stop now ready to deploy an exit strategy. Is this a wait a few days and look for a double? Roll down? Or convert this dead money into profits? Can you help me analysis the factors from where I should make the Decision? With bubble talk, being below 20 sma, but still much better than market and taking in consideration that I knew the volitility was higher to start should I just ride the wave? Any insight would help. Thank you.

    • Alan Ellman June 26, 2015 12:51 pm #

      Nate,

      Chinese stocks are getting crushed today:

      http://blogs.barrons.com/asiastocks/2015/06/26/shanghai-down-7-7-first-large-wave-of-margin-contracts-expires/?mod=yahoobarrons&ru=yahoo

      ASHR has been one of our best-performing ETFs for nearly a year now but does have high implied volatility (and therefore risk) as I wrote in a recent blog:

      http://blogs.barrons.com/asiastocks/2015/06/26/shanghai-down-7-7-first-large-wave-of-margin-contracts-expires/?mod=yahoobarrons&ru=yahoo

      Now, you bought back the option…nice. On one hand, we are early in the contract with so much time to recover so we may look to “hit a double” On the other hand, it’s an entire exchange impacted so there is more than average concern. That said, things can turn around on Monday.

      When I have forces pulling at me in opposite directions I will frequently take both sides. If I held 4 contracts, I may roll down with 2 and hold the other 2 for “hitting a double”

      I can’t give financial advice in this venue but there is no rule that you have to use the same tact when holding multiple contracts. Later in the contract, stronger consideration is given to rolling down and selling the stock.

      Alan

      • Nate June 26, 2015 2:48 pm #

        Thank you Alan for your response. I know exactly what I will do with my position.

        At the start of the contract period when I have multiple contracts, depending on my overall assessment, I will do some ITM & OTM. I haven’t considered staggering the strike price after implementing the 20/10 rule. Just one more tool in my arsenal. Nice.

        Also taking the common sense principle of proper diversification into account one or two positions are not going make or break this month’s return. Mitigating losses through exit strategies does even less “damage” to the overall return. I am using your methodology for life. It just aligns with me so well.

        BTW I really enjoyed your interview on 52 traders. I never read your first book so it was cool to hear your back story and all the other info you shared. Great stuff!

        • Alan Ellman June 27, 2015 6:14 am #

          Thanks Nate, I’m energized by your enthusiasm.

          To our members:

          The podcast Nate is referencing is embedded in our 6-27-15 blog article…Enjoy.

          Alan

  18. Barry January 16, 2016 5:35 pm #

    Hi Alan,

    I’m enjoying your second encyclopedia very much..

    I was wondering, do you use the “Show and Fill Rule” every time?

    The way I see it, why wouldn’t you?

    Or… Do you just use it only when the spread is greater than 0.30 (30 cents)?

    And, at what point do you drop an option strike price form your choice when looking at the spread?

    What I mean by that is, say a stock passes all the criteria. Say the ROO = 2.0%, but the spread is say 0.80 (80 cents).
    Would you not consider it because the market maker probably wouldn’t accept a limit of (Bid Price – 0.35)?

    Would you drop it because if there is such a large spread, it’s probably too volatile?

    And last but not least, do you have an article in your books or online that goes into detail about spreads, what they mean and how a “regular person” should look at them and think about them? (The thing I have learned about them is that the wider they are, the more volatile it is considered.)

    Thank You

    • Alan Ellman January 18, 2016 7:50 am #

      Barry,

      As a guideline, I will tend to leverage the Show or Fill Rule when the spread is greater than $0.10. For example, if the spread is $1.00 – $1.15, I’ll set a limit order for $1.05. Every dollar counts! For smaller spreads, I’ll set the limit order at the published bid as long as the returns meet my goals…remember the price could decline if we delay too long. Regular person perspective analogy: You’re selling your house and want $200,00 for it.. The buyer offers $190,000…well maybe. He offers $150,000…take a hike! If you’re too far apart to begin with, it generally will not work. Now an $0.80 spread negotiated successfully may still end up settled with a wide spread where it would be too costly if the option needed to be bought back. Have the confidence to walk away from a potential uncomfortable future situation. Open interest (liquidity) plays an important role in this as well. Much more information in my books and DVDs.

      Alan

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