Covered call writing is a popular and potentially highly rewarding strategy geared to retail investors. But most blue collar investors work 9-5 jobs and managing investment positions can be challenging if no common sense plan is in place. The purpose of this article is to discuss ways that we can keep track of our positions and generate cash flow of passive income (investments) while still generating active income (going to work). Let’s first breakdown the 4 stages of covered call writing:
- Stock selection
- Option selection
- Trade execution
- Position management
Stock selection
This aspect of our strategy can be accomplished in the evenings or on weekends. For those of you who are or will become premium members, the BCI team will do the screening for you and save you a significant amount of time. Here is a view of the ‘running list” which is the watch list we provide to our members as located in the mid-portion of our stock reports:
Premium Stock report: running list
All stocks located in the “white cells” are eligible candidates for consideration. Our typical running list has between 40-60 eligible stocks for covered call writing in addition to our 15-20 exchange-traded funds candidates which we provide to our members in a separate report.
Option selection
Once our watch list has been established, we can check the calculations by accessing the options chain and using the multiple tab of the Ellman Calculator. 90% of this work can also be accomplished in evenings and weekends but will need to be re-checked prior to trade execution during hours when US markets are open (9:30 AM to 4:00 PM ET, Monday through Friday).
Trade execution
Here is where we need to find a small time slot mid-week once or twice a month. Most of our trading will take place just prior to expiration of our contracts (the 3rd Friday of the month) or the beginning of the following week. All the preparation can be done in advance but market pricing changes so all orders need to be re-checked prior to execution. As you master the strategy this will not take a lot of our time. I like to enter my covered call trades between 11AM and 3PM ET when the market volatility is at a minimum. How about during a lunch hour? Again, it’s only once or twice a month as you set the tables in the evenings or on weekends.
Position management
Here is where we must become creative. In my books and DVDs, I detail the 20/10% guidelines which dictate when and if to buy back an option. Once our trades are entered, we immediately enter limit orders to buy back the options @ 20% in the first half of the contract and 10% during the second half. In essence, we are instructing our broker to close our short options positions if the price of the option we originally sold declines to 20/10% of its original value or less. If the price does not reach that level, the trade is never executed. However, it does, the option will automatically be bought back and an email sent to us notifying us of the trade. We can then make a decision that night or over the weekend what path to follow now that our option obligation no longer exists. Once again, position management techniques are highlighted with examples in my books and DVDs. Follow-up exit strategy trades may require a small number of lunchtime sessions of 5-10 minutes. The chart below shows what a trade execution form may look like after entering a covered call position and setting up a limit order to buy back that option (buy-to-close). In this hypothetical, we buy EDU @ $28 and sell the $30 call @ $1 (sell to open). We then set a limit order (that amount or cheaper) @ 20% or $0.20:
Limit order to buy back the $30 call
Using this technique means we don’t have to constantly watch our positions and by placing a “good until cancelled” order, it remains in effect until executed or we change it (also done after hours). Now, mid-way through the contract we change to 20% to 10% (evenings or weekends), in this case the limit order will be @ $0.10 and also “good until cancelled”
Summary
Covered call writing does require us to be available during market hours for an hour or two a month. By educating ourselves and mapping out a non-emotional common sense plan based on sound fundamental, technical and common sense principles, the time required during these hours can be minimized and made manageable while still working a full-time blue collar job.
Next live seminar:
NEW YORK
Long Island Stock Traders Investment Group
Monday, March 10th
6:45 PM – 9:30 PM
Plainview Old Bethpage Library
999 Old Country Rd, Plainview, NY
Market tone:
Despite the extreme weather conditions, the economic reports continued to show an improving economy:
- According to the Labor Department, 175,000 jobs were created in February, more than the 150,000 predicted
- Despite this increase, the unemployment rate ticked up to 6.7% from 6.6%
- Consumer spending rose by 0.4%, more than the 0.1% expected
- Construction spending rose by 0.1% while analysts were predicting a decline of 0.3% New residential construction rose by 1.1% while non-residential construction declined by 0.2%
- According to the US Department of Commerce, factory orders declined by 0.7% (0.5% was anticipated) due to slow growth in construction and decreased demand for cars and semiconductors
- The US trade deficit widened by 0.3% in January, in line with expectations
- Personal income increased by 0.3% in January after being flat in December, mostly due to the impact of Affordable Care Act provisions
- According to the Institute of Supply Management (ISM) the manufacturing sector rose to 53.2 (showing expansion) in February, more than the 51.6 stat expected
- The ISM non-manufacturing index came in at 51.6 in February, below the 53.5 predicted
For the week, the S&P 500 rose by 1.0%, for a year-to-date return of 2%, including dividends.
Summary
IBD: Confirmed uptrend
BCI: This site remains cautiously bullish, favoring out-of-the-money strikes 3-to-2
Thanks for all your support.
My best to all,
Alan ([email protected])
www.thebluecollarinvestor.com
Premium Members,
The Weekly Report for 03-07-14 has been uploaded to the Premium Member website and is available for download.
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 BCI YouTube Channel link is:
http://www.youtube.com/user/BlueCollarInvestor
Best,
Barry and The BCI Team
What does this mean- “This site remains cautiously bullish, favoring out-of-the-money strikes 3-to-2”? Does that mean if using five positions, three should use OTM strikes and two should use ITM or ATM strikes?
Tom,
I am sharing with our members the makeup of my current portfolios based on my market assessment and personal risk tolerance. This may differ from investor-to-investor but I’m happy to share my outlook and action taken. It means that approximately 60% of my cc writing portfolios (I have several) consist of writing out-of-the-money strikes and 40% are in-the-money, a slightly bullish approach.
Alan
I am a subscriber and I will be cancelling the credit card connected to this site and replacing it with another.(within the next month or so) How do I forward the new card Information?
Richard,
You will receive a link specific to your membership that will allow you to update your member information. You can also send updated information directly to me:
[email protected]
(for my eyes only)
Thanks,
Alan
I’m traveling and downloaded the weekly report to my tablet and the file will not open. Mesage not a valid pdf. Tried Adobe and anther program. This always worked on my computer and laptop?
Frank,
It must be from your end because I have received no other comments along these lines.I emailed to you my copy of this week’s report.
Alan
Frank,
To check to see if there is a problem, I went to the Premium website and downloaded the 3/7/14 Weekly Report to 3 different devices. The report successfully downloaded and opened using:
– iPad (IOS 7.0.6)
– Android Galaxy Tab 7 (Android 4.2.2)
– Kindle Fire (6.3.2)
I have noticed that on Android, Adobe Reader occasionally does not behave properly. To further check on the issue, I then downloaded the following Android Apps:
– FoxIt PDF Reader
– Polaris Office (I believe that this is bundled with the Android)
– Kingsoft Office
All three of these Apps have built-in Adobe readers and the report opened successfully with them as well. I think that one of these will help you. If you continue to have problems, please get back to me at:
[email protected]
and we’ll work the issue.
Best,
Barry
Thanks Alan, It didn’t cross my mind to set a buy to close limit order at 20% as soon as sell the option. Great idea!
Thanks to your teachings and your Exit Strategies book this month I was able to buy IACI for 74,76, sell the 75$ option (2,9 ROO). A week later I used your Mid-Contract-unwind-stock price goes up strategy, BTC, Buy URI for 90,39 and sold the 90$ option for another 2,3 ROO. I recieved in total 498 $. AMAZING!!
Thanks so much!
Hi Alan,
Is it possible to copy/paste Stock symbols + current stock price from the Premium List (Adobe Reader) into the Ellman calculator multiple Tab (Excel). I’m currently doing this manually and it would be very helpful if somebody could tell me how to do this. I’m still using Excel 97 (I know!!!!)
Thank you,
Martin
Virtual options order form:
The original screenshot in this article showed a limit order to buy back a $28 call. That was a typo and should read $30 call (the one originally sold) as now highlighted in the updated screenshot. Thanks to those members who alerted me to this matter.
Alan
Alan,
Thank you for a wonderful seminar last night at the LI Stock Traders Meetup Group!
1) While holding a stock position can you write an out of the money Call and an out of the money Put at the same time? If so, do you recommend it?
2)In an up trend would it be better to write an at the money or in the money Put rather than an out of the money Call?
Thank you !
Regards,
Paul
Hi Paul,
Thanks for attending my presentation last night.
There is actually a name for this strategy…a covered strangle (not my area of expertise). It is more involved than a covered call and therefore appropriate for more sophisticated investors. It is a popular options strategy.
This strategy consists of two parts: (1) short a call and long the underlying stock, and (2) short a put with sufficient cash to purchase the stock if assigned. This is a combination of the covered call and cash-secured put strategies I mentioned last night. If the stock rises above the call strike at expiration, the investor is likely assigned on the call. If the stock falls below the put strike at expiration, the investor is likely assigned on the put and obligated to buy more stock at the put strike.
The strike price selected for a short put will depend, to a great extent, on whether you are inclined to take possession of the stock. If no, go deeper OTM.
Alan
Hi Alan,
I am on a 1 month’s trial subscription. I wonder if you cater for weekly stock options listings? I hope so. I would like to find out companies that would allow me to purchase long married puts and still come out with a profit. Is that possible without using a highly volatile stock with risky high premium?
Ken
Ken,
Both our stock and ETF reports identify securities that have both passed our rigorous screening process and also have weekly options associated with them. As you know, protective puts will protect against a catastrophic downturn in share price but also decrease our premium returns. You can absolutely generate a profit w/o using volatile stocks as long as the put if further out-of-the-money than the call. Once you determine what your goal is, you can then decide which securities are appropriate for the strategy you are using.
Alan
Hi Allen
I am confused about placing a limit order or stop loss order for protection. I read that with a limit order there is a danger of the stock or option gaping past the limit (premarket) and then your losses could grow without the limit ever being hit. The stop loss will definitely stop you out, but because it becomes a market order the price you get stopped at is not exactly at the point you requested.
You are a very smart and successful investor could you clarify why you use a limit order instead of a stop loss order?
Thanks Greg
Greg,
The concept behind the 20/10% guideline is twofold. First we want to put ourselves in a position to mitigate losses, turn losses into gains or enhance gains. This means closing the short options position first. Second, we want to retain 80-90% of the original option profit because that is our goal when using the strategy of cc writing…generating time value cash flow.
When it comes to buying back the option, our limit order is @ 20% or 10% depending on how close to expiration we are. Let’s assume we are early in the contract and the 20% guideline applies. Let’s further assume we sold the original option for $2. We place a buy-to-close limit order @ $0.40. This means that the trade will be executed @ $0.40 or better (less than $0.40). If the option price gaps down below the $0.40 price it simply means that we will spend less money to close our short position. Whether the trade is executed @ $0.40 or less, we are now in a position to wait and re-sell the same option if share price recovers, sell a lower strike option (roll down) or sell the stock. My books/DVDs give guidelines, details and examples of the various scenarios.
BTW: Thanks for calling me smart…just confirms what my mother has been saying all these years!
Alan