beginners corner

Margin Accounts and Covered Call Writing

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.

30 Responses to “Margin Accounts and Covered Call Writing”

  1. admin July 30, 2011 9:27 am #

    Premium members:

    As a follow-up to yesterday’s post- power has been restored after last nights severe weather and we are currently researching the information for this week’s stock report. We’re back!

    Alan and the BCI team

  2. Barbara July 31, 2011 8:14 am #

    The 3 month returns on the latest etf report are much lower than in previous reports. I’m sure this is related to the current market turpoil. When this happens would it be better to favor individual stocks or maybe just stay on the sidelines until market conditions improve?

    All thoughts appreciated.

    Barbara

  3. Barry B July 31, 2011 11:12 am #

    Barbara (#2),

    This is my personal opinion…

    I am extremely conservative…maybe even more conservative than Alan…if that is possible :) :) :) In the current market, because of “headline risk’ around every corner, I’m on the sidelines waiting the more clarity. Using Alan’s methodology, we can work around most issues except news…and news can kill you. I’ve paid a lot in “tuition” (aka big losses) learning this lesson…not paying attention to headline risk (and ERs can be put into this category as well).

    So, my short term tactic for situations like this is I use the “HIP” plan…”Hands In Pockets”…not on the keyboard. Once the unknowns, good or bad, are known, then we can move forward.

    Best,

    Barry

  4. Barry B July 31, 2011 5:07 pm #

    Premium Members,

    The Weekly Report has been uploaded to the Premium Member website. Look for the report dated 7-29-11 REVA.

    Best,

    Barry

  5. Paul August 1, 2011 6:52 am #

    Does anyone know the percentage of options that are actually exercised? If I were an option buyer I would rather sell the option than exercise.

    Thanks.

    Paul

  6. admin August 1, 2011 10:19 am #

    Paul,

    You’re not alone…very few options are exercised. Here are the statistics for 2010 according to the Options Clearing Council:

    Closing sells: 71.6%

    Unexercised @ expiration: 20.5%

    EXERCISED: 7.9%

    It is clear that a huge majority of investors who purchased our call options sold rather than exercised them.

    Alan

  7. admin August 1, 2011 12:41 pm #

    Premium members:

    This month’s list of high dividend yield stocks with LEAPS has been uploaded to your premium site. Look in the “resources/downloads” area for the report titled “High Dividend Stocks with LEAPS August-September”.

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

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

    Not a premium member:

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

    Alan and the BCI team

  8. Brian August 1, 2011 7:31 pm #

    Alan,

    In your dvd set you say that options are rarely exercised prior to expiration Friday but they are American style options that can be exercised at any time. If the strike price is lower than the market price why wouldn’t the option buyer exercise early?

    Thanks (the dvds are great).

    Brian

  9. Kerrie Setiawan August 1, 2011 11:13 pm #

    I’ve observed that options are rarely exercised prior to expiration. If the strike price is lower than the market price, the call option can be sold for a profit if it was purchased at a lower market price.

  10. admin August 2, 2011 6:41 am #

    Brian and Kerrie,

    Options are rarely exercised prior to expiration Friday despite being American style options due to the “time value” component of the option premium. Let’s say we sold a $35 call on a stock trading @ $38 mid-contract. The premium would consist of intrinsic value ($3 in-the-money) + time value, let’s say $0.50 for a total premium of $3.50. If the option holder exercised his right to buy @ $35 he could then sell @ $38 for a credit of $3. If instead, he sold the option for a $3.50 credit, he would capture both the intrinsic + time value. Why lose the $0.50? An exception would be to capture a dividend prior to the ex-dividend date. Here assignment MAY occur if the dividend is greater than the time value of the premium.

    Alan

  11. Brian August 2, 2011 2:43 pm #

    Thanks Alan. This makes sense. One more question please. In your dividend example if the time value is less than the dividend how can we avoid having our shares sold?

    Thanks again.

    Brian

  12. owenCPA August 2, 2011 2:48 pm #

    Brian and Kerrie,

    You really need to put yourself in the buyer’s shoes to see why he might not exercise early. Ignoring the “capture the dividend” feature, let’s say I paid $4.50 for a call option. I now control 100 shares of stock for $450. If the stock is well in the money, each dollar the stock rises, my “investment” rises $100.

    Let’s suppose we are talking about a $38 stock. I can call the stock, and pony up $3,800, or keep my option, which I bought for $450. Now, the stock rises $1. My $3,800 investment goes to $3,900, an increase of 2.63%. My option would have gone from $450 to $550, an increase of 22.22%.

    Class dismissed. Happy trading.

  13. owenCPA August 2, 2011 4:38 pm #

    Brian and Kerrie,

    There is another reason why an option buyer might exercise early: if he is a short seller getting whacked.

    If I sell a stock short I may buy a call option in case the stock heads up, instead of down. Let’s say I borrow shares of XYZ and sell them at $38. I migh buy a $40 call, just in case the stock goes up. Now, I am hoping that it will go to $6, but suppose it goes to $46. Now I already have a paper loss of $8. I finally throw in the towel to close my position. I exercise my call and turn over the shares to the lender. I am now out of the position.

    Since the exercise is assigned randomly, the computer will look around for any call that someone sold and still has outstanding. Depending on the current open positions, that assignment just might fall on your account. It’s nothing personal. I just got tired of watching my loss keep getting bigger.

    Anyway, that is one of the reasons why an option buyer might call in a stock early.

  14. admin August 2, 2011 5:31 pm #

    Brian (#11),

    You can buy back the option in advance of the ex-dividend date and assure that you will capture the dividend. However at that point you would be engaging in a different strategy. There is nothing wrong with combining strategies if that’s what works best for you. It’s important to be focused like a laser to maximize returns and that means identifying the strategy you are employing and the goals you are setting. If your decision is covered call writing 1-month options and you happen to lose a dividend in the process, congratulate yourself for achieving your goals and perhaps use the cash to start a second income stream with the same cash in the same contract cycle.

    Alan

  15. Amy August 3, 2011 8:24 am #

    With the market down 8 days in a row, is this a good time to enter or wait to confirm a bottom? Futures look good this morning. Any thoughts appreciated.

    Amy

  16. Mark T. August 3, 2011 10:20 am #

    With 8 down days I have hit the 20% exit criteria on about half my positions. I have not resold calls as I have expected a rally and did not want to limit my upside, I was going to wait for them to rebound some and then sell calls. They have not gone down far enough to hit what I call my “get out price”. What to do? I assume many of you have the same situation, any ideas? I hate just sitting on my hands!

    Mark Tooker

  17. Mark T. August 3, 2011 10:41 am #

    I should correct my #16 post above. I bought Sept and Oct puts as insurance on some of these positions and some of them are now ITM. Since I don’t have any further downside risk on them I am sitting on them waiting to see what happens. I sold the puts (at a profit) on the positions that are holding up good.

    Mark Tooker

  18. Fred August 3, 2011 10:44 am #

    I am waiting two more days. I also closed my short calls. On Thursday or Friday I will resell, roll down or close my long stock positions depending on chart technicals. Friday’s unemployment report will be big. Just my 2 cents.

    Fred

  19. admin August 3, 2011 7:15 pm #

    Mark and Fred,

    The decision as to whether to unwind our positions or use a different exit strategy like rolling down as Fred alluded to depends on one’s risk tolerance. The no-brainer is to buy back the option when it meets the 20%/10% guidelines. Those of us who have experienced volatile markets like we have had recently or even bear markets are more likely to hold on for the short term and new investors will tend to unwind. If you can’t sleep at night unwinding until there is calm in the markets is probably a good idea. None of us like the volatilty we have experienced over the past two weeks and certainly some economic reports have been partially responsible. However, the degree of negative impact has been exacerbated by the egregious behavior of our politicians. These are the folks who are supposed to represent our best interests. Shame on them! The markets WILL recover despite them and we can address their actions at the next election.

    (trying hard not to get too political)

    Alan

  20. admin August 3, 2011 7:20 pm #

    HFC:

    The Board of Directors announced today a SPECIAL cash dividend of $1 per share payable on August 22nd to holders of record on August 15th. The stock will also split 2-for-1 on August 31st. The next ER is due on August 5th.

    Alan

  21. admin August 4, 2011 6:49 am #

    ROC:

    On July 27th announced its 8th consecutive positive earnings report (2nd quarter) as this company has averagred a 21% positive surprise over the past 4 quarters. EPS were up $1.19 compared to a consensus of $0.97. Sales increased by 23%. For the first 6 months in 2011, sales are up over 20%. It stated that demand remains strong and expects margins to remain high and EPS improving. Growth is expected to be 92% for 2011 and another 18% in 2012.

    ROC trades at a forward PE of 14 and a price-to-book of 2.5, both stats showing good value. ROE is a solid 16.6%. On our premium watch list for 5 weeks we see an industry segment ranking of “A” and a beta of 1.87.

    Alan

  22. admin August 4, 2011 3:48 pm #

    Just like 2008? I don’t think so:

    I’ve had a few offsite emails from long-term investors expressing how the current market behavior reminds them of 2008. Certainly moves of several hundred points in a day is reminiscent of “the bad ole days” but what is the underlying cause? Is it the same? Listening to the “experts” on TV and radio we see a myriad of opinions ranging from a doom and gloom scenario to “this is a temporary setback and a buying opportunity”. The smartest of these assessments will be determined in the future as we look back. Some will be right, some wrong.

    To me, this has a different feel than 2008. The idiocy of the sub-prime debacle was a major driving force to the recession of 2008. Now we are in sluggish recovery but a recovery nonetheless. We have global concerns (see Europe) and unemployment issues that are not improving as quickly as any of us would like. For the most part corporations are reporting favorable earnings with many more positive than negative surprises. With this backdrop I would expect an appreciating market moving upward at a slight angle from the perpendicular, not a rocketship to the moon. We had that until recently. So what has changed? Economic reports? They have been mixed since September of 2010 as I have memorialized in my weekly blog articles.

    My feeling is as I stated in comment #19…the world is watching us and no longer feels that we (our political leaders) can manage our affairs. It’s more than embarrassing, it’s a shame. Too many people are getting hurt by the irresponsible behavior of our Congress. The folks are partially responsible as well as we put them in office. We can fix that problem!

    The good news is that historically the markets correct on their own despite these negative influences and there’s no reason to believe that it won’t continue to do so. As with the others, my assessment can only be evaluated after the fact. I may feel that the Yankees will make the playoffs this year and give you ten reasons why. In October, we can evaluate that prediction.

    Here’s to the playoffs!

    Alan

  23. admin August 4, 2011 5:11 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.

    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

  24. owenCPA August 4, 2011 5:42 pm #

    I am writing my members of Congress and the Senate to tell them I was all set to write them a campaign contribution check, but their selfish, pigheaded, stupidity crashed the market, and now I can’t afford to send them any money. Oh, well….

  25. admin August 5, 2011 11:09 am #

    I have received dozens of emails over the past few weeks with members expressing their disgust for Congress. They have had it! Many of you have probably seen an email being sent around titled “How to Fix Congress”. It is not the purpose of this site to take a political tone however our representatives are impacting our wallets in a negative way…big time, so I thought I’d share this email with you:

    “This is one idea that really should be passed around. Congressional Reform Act of 2011:

    1. No Tenure / No Pension. A Congressman collects a salary while in office and receives no pay when they are out of office.

    2. Congress (past, present &future) participates in Social Security. All funds in the Congressional retirement fund move to the Social Security system immediately. All future funds flow into the Social Security system, and Congress participates with the American people. It may not be used for any other purpose.

    3. Congress can purchase their own retirement plan, just as all Americans do.

    4. Congress will no longer vote themselves a pay raise. Congressional pay will rise by the lower of CPI or 3%.

    5. Congress loses their current health care system and participates in the same health care system as the American people.

    6. Congress must equally abide by all laws they impose on the American people.

    7. All contracts with past and present Congressmen are void effective 1/1/12. The American people did not make this contract with Congressmen. Congressmen made all these contracts for themselves. Serving in Congress is an honor, not a career. The Founding Fathers envisioned citizen legislators, so ours should serve their term(s), then go home and back to work”.

    (Me now): By taking away Congress’ candy and video games perhaps they will learn how to behave properly.

    Alan

  26. owenCPA August 5, 2011 5:17 pm #

    Pretty good, Alan.

    One of my thoughts is amending the constitution to allow only one Senator from each state, and doubling the population per House member. That cuts the size of Congress in half and eliminates 1,500 support staff. It’s a start.

  27. Mark T. August 6, 2011 12:08 pm #

    Just when it looked like maybe the worst was over the downgrade came last night. What to do? It sure will be another interesting week. The worst part is having the whole weekend to think about it.

    Mark Tooker

  28. owen August 6, 2011 2:08 pm #

    Perhaps Congress can save some time. When they hold those hearing about why the credit agencies didn’t sound the warning about the fincancial disaster the banks were getting into in 2008 and 2009, they can also ask how the same credit agencies can possibly consider the US financial condition is anything but perfect.

    Can you spell hypocritical?

    So, again, if con is the opposite of pro, is Congress the opposite of Progress?

    If you choke a smurf, does he turn the same color as Boehner defending tax cuts for millionaires and benefit cuts for Social Security recipients?

  29. admin August 6, 2011 2:56 pm #

    I’ve spoken to a few Wall Street insiders who feel that the recent downgrade will not have a major negative impact on the market. They regard it as a “slap on the wrist” almost a warning to get our act together. That is why (they hypothesized) only one of the three agencies acted on a downgrade.

    Premium members: As my team works on this week’s report, we anticipate most stocks to end in the “pink” cells as market forces are impacting even the best performers. We are also working on a second report, an “Emergency Special Report” discussing management tactics and strategies when market forces are negatively impacting share value. As with the regular weekly report, we will send out an email to our members and post on the blog when this “extra premium report” is available.

    Alan

  30. Adrian April 19, 2012 3:35 am #

    That’s an interesting article on margin accounts, just a pity there are hardly any questions related to it!
    But I have 3 things that I am not quite sure of(in case I ever were to use margin loans), and they are:-
    -First I have read that if I had a margin loan, that I should always have a minimum of 20% of my portfolio in my account(as margin) to cover a margin call. But does this seem right?, and if so then would I even need an amount of 20% or would a lesser amount do instead?

    – I have also read that in order to use margin loans, I need to have a high ‘taxable income’, and be a low ‘marginal tax-payer’.
    Can you tell me if this is true?, – and if so then is there any way I could use a margin loan, as I don’t have a high taxable income?

    – Also how would we know that we are so experienced at this strategy, to be able to use them?

    If I ever get really good at this strategy then I may possibly use them, even though I think they are pretty risky, and would rather go for any other type of loan if needed first! thanks

Leave a Reply

Optionally add an image (JPEG only)