beginners corner

Protective Puts- The Collar Strategy

As safe a strategy that covered call writing is, there is some risk…the risk is in the stock, not in selling the option. That is why some investors who utilize this strategy buy protective puts to alleviate some of the risk.

Definition of a protective put:

A put option purchased for a stock that is already owned by the owner of the option. A protective put defends against a decrease in the share price of the underlying security. When a protective put is used in conjunction with covered call writing, the strategy is referred to as a collar strategy. A collar in options trading is the owning of the underlying shares while simultaneously selling the call options and buying protective puts. In a true collar strategy the puts and calls are both out-of-the-money having the same expiration dates and equal number of contracts. So we sell an O-T-M call and protect the downside by purchasing a put.

Example of a Protective Put/Collar Strategy:

  • Buy 100 x Company XYZ @ $48
  • Sell 1 x $50 call for $2
  • Buy 1 x $45 put for $1
  • Net gain on the option buy and sale is + $100 ($200 – $100)
  • This brings our cost basis down to $4700 ($4800 – $100)

Outcome if stock price surpasses the $50 strike price:

  • Shares are sold for $5000 (50 strike x 100 shares)
  • Results in a profit of $300 ($5000 – $4700)
  • ROO = 300/4700 = 6.4% 

Outcome if stock prices falls below the $45 strike price to $43:

  • Shares are sold for $4500  (not $4300) because of the protective put
  • Net loss is $200 ($4700 – $4500) = (-) 4.3% 

Outcome if stock price remains @ $48

  • ROO = $100 ($100/$4800) = 2.1% 

Chart of possible outcomes:  

Protective Puts- The Collar Strategy

 The profit potential is muted due to the cost of the protective put but the downside risk is protected at the strike of the put. If you exit the covered call position early, you can sell the remaining protective put improving the return slightly.

Tax treatment of Protective Puts:

When the protective put is purchased on the same day as the stock, it is referred to as a married put for tax purposes. To calculate capital gains or losses, the investor adds the premium paid for the option to the purchase price of the stock to calculate the tax basis of the stock. For example, you buy 200 x ABC @ $30. On the same day, you purchase 2 x $25 puts @ 2. The tax basis of the stock is $6400 ($6000 + $400).

The case against protective puts:

Let me premise these remarks by saying that there is nothing wrong with purchasing protective puts. I feel, however, that we can get our insurance for free by educated, well-calculated and common sense investing. Here is what the Blue Collar Investor System does to alleviate risk without spending cash for insurance (protective puts): 

  • Select only the greatest performing stocks.
  • Select equities in the best performing industries.
  • Avoid earnings reports, the most likely cause of a radical share downturn.
  • Avoid companies that report same store retail sales.
  • Sell I-T-M strikes when market tone and/or stock technicals are compromised. In this case, the option buyer is paying our insurance.
  • Use technical analysis to determine buy-sell points.
  • Implement exit strategies when needed.
  • Sell predominantly 1-month contracts for better control.

The only time a protective put will benefit us over and above our system’s inherent protection, is when a stock drops precipitously in a short period of time. This can occur after an earnings report but we are already avoiding these reports. Otherwise, such events are few and far between but possible. Therefore, in my judgment, it doesn’t pay to purchase a put every time you sell a call option. You’re just not getting enough bang for your buck as long as you do your due diligence and follow all the system criteria.

Premium Members 10% Discount:

Several of our newer premium members have inquired how to take advantage of the 10% discount member perk. It’s simple:

1- Login to your premium site.

2- Scroll down to the lower right side of the page.

3- Click on the link to gain access to the store.

4- A 10% discount will be credited to your account @ checkout. See the link below:

Link to Premium Discount

 

Market tone:

Not surprisingly, the reports were mixed but leaning more to the positive this past week:

  • Industrial production fell by 0.2% in September, the biggest decline since June 2009.
  • Housing starts were up by 0.3% in September but total housing permits declined by 6%.
  • The Federal Reserve’s Beige Book of economic conditions found the economy growing in September and early October but at a “modest” pace.
  • The Conference Board’s index of leading economic indicators increased by 0.3% in September and concluded “There isn’t any indication of a relapse into another downturn through the end of the year.”
  • For the week, the S&P 500 was up 0.6% for a year-to-date return (with dividends) of 7.8%

The Golden Cross: Short term moving average moves above the long term moving average:

The Golden Cross indicates a bull market on the horizon and is reinforced by high trading volumes. Additionally, the long-term moving average becomes the new support level in the rising market. Let’s view a chart of the S&P 500 using the 50-d and 200-d simple moving averages:

The Golden Cross

Note that the shorter term 50-d sma (blue arrow) just moves barely above the longer term 200-d sma (red arrow) at the green circle. This golden cross is strengthened by recent increasing volume (black line at bottom).

Summary:

IBD: Market in a confirmed uptrend

BCI: Moderately bullish selling a greater percentage of O-T-M strikes. In addition to the favorable economic reports and the positive technical patterns developing, the earnings reports have been quite strong thus far and this bodes well for the near term market. Yet to be determined is the impact the upcoming elections will have on the stock market.

My best to all,

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.

60 Responses to “Protective Puts- The Collar Strategy”

  1. owen October 23, 2010 12:13 pm #

    Note for IRA accounts:
    Many IRA brokers will not allow you to buy a put in your IRA account. A few will, so ask them.

    Note on the tax treatment of puts:
    The cost of the put is added to the cost basis of the stock IF the put is exercised (you make the other party buy your stock). If the put expires worthless it is reported as a short term capital loss with a cost basis of what you paid and proceeds of “Expired”. (See page 58 of IRS Publication 550 http://www.irs.gov/pub/irs-pdf/p550.pdf)

    Don’t get carried away with using the put as a downside protection. In Alan’s example above you might find that selling the $45 call gives you the comfort level you desire, instead of selling the $50 call and buying the $45 put. But, don’t get greedy, either. Buying the “insurance” of the put costs you $1 of your possible $2 option profit, but you still get a 2.1% return if the stock stays at $48, and a 6.4% return if it gets called away. Still not bad.

  2. owen October 23, 2010 12:32 pm #

    Sorry, the IRS link above highlighted the right parenthesis and messed up the link. Use:

    http://www.irs.gov/pub/irs-pdf/p550.pdf

  3. Mike October 23, 2010 1:08 pm #

    Alan–

    I have been using buy-writes to write CC deep in the money. I am relatively certain that the stock will get called at the strike price because they are so deep ITM.

    I have been going to the buy-write area of a trading platform and selecting a strike and net -debit which produce a profit which I desire and I calculate the yield as the difference between the net debit and the strike devided by the net debit. Is this correct.

    If I select a strike of 95 on a stock such as ABC which is trading at 100 and if the option premium is 7 the net debit is 93. So I buy at the net debit of 93 and sell the stock at 95. My profit is 95-93=2

    My yield would be 2/93=2.15 %

    Am I correct in my thinking and calculations.

    Thanks for all you do for us–

    Mike

  4. Don_B October 23, 2010 1:16 pm #

    Alan –

    Loved your explanation on the Golden Cross indicating a coming bull market. Noting that you use Simple MA of 50 and 200 day, would I want to make the same assessment using EMA of 20 day and 100 day? Such as when I see an individual stock making that cross on my chart?

    Doesn’t it look like there is a falloff of Volume at the right end of your black line? In fact, that falloff takes volume to less than anywhere on the chart. ???

    Don B.

  5. admin October 23, 2010 4:25 pm #

    Premium members:

    This week’s “Weekly Stock Screen and Watch List” has been uploaded to your premium site. In an effort to constantly upgrade the quality of the product we provide, you will note that another feature has been added:

    We will enter a “c” in the “comments” column indicating that an ER date has been confirmed on the earningswhispers.com site.

    Alan

  6. admin October 23, 2010 4:35 pm #

    Mike (#3),

    Given your assumption that the stock will be called @ the selected strike, your calculations are accurate. In this scenario you are taking the profit at month’s end. My calculator views the investment from a slightly different perspective where the profit is taken at the beginning of the cycle and then re-invested so the cost basis does not deduct the time value of the premium. It also does not make any assumptions regarding the final outcome of the investment and allows for exit strategy executions. Nothing wrong with your approach. It’s simply a different philosophical view of the strategy and would have maximum application with the deep I-T-M strikes you are using.

    Alan

  7. admin October 23, 2010 4:49 pm #

    Don,

    1- In our BCI system, we select stocks where the 20-d ema is trading above the 100-d ema so the golden cross would not have application for stocks we own or those on our watch list. However, when I see a stock where the 20-d has broken above the 100-d especially if it’s on high volume ( a volume surge of 1.5 x normal volume is especially significant), I take notice and may want to jump on that train ride that may generate big profits for us. You will note that to determine general market conditions I always use longer term moving averages.

    2- When the market has been trending up for a few months, I look at the general pattern of the volume, not an individual day or two. Over the past few months the 50-d sma has been moving closer and closer to the 200-d sma on generally increasing volume. This tells us that as the institutional investors are returning from their summer vacations (a light volume time period historically), there is a bullish tendancy as they reposition their portfolios.

    Alan

  8. Don_B October 23, 2010 6:35 pm #

    Alan –

    On post #7, on your comment 1, I do get it now. However, the reason I asked is that BCSI, which I unfortunately still possess, has done precisely that. On Oct. 11, the 20 day EMA crossed higher than the 100 day. Matter of fact, the price did too, that day.
    So ASSUMING I HAVE A STOCK NOT IN BCI, is that Golden Cross indeed bullish? And does the reverse also apply?

    Thanx for your patience.

    Don B

  9. Don_B October 23, 2010 6:42 pm #

    Alan –

    Perhaps my timing of this question/commentary is not the best – but here goes.

    Since there seems to be market studies relating to the election cycle, and others relating to the superbowl, does it follow that there would be one relating to ‘THE YEAR THE YANKEES LOST THE PENNANT” ? (VERY BIG GRIN!!!)

    Sorry, I just could not pass up the opportunity!!

    Best of everything from……….

    Don B

    (who is not a Texas fan, or even an American League fan}………………………..

  10. admin October 23, 2010 9:26 pm #

    Don,

    The crossover of short and long term moving averages on high volume is a very significant technical event in either direction. BCSI has been coming on strong up almost 50% from its lows.

    Now about your Yankee comment:

    Ouch! You sure know how to hurt a guy.

    Alan

  11. Don_B October 23, 2010 10:08 pm #

    Alan –

    -GRIN –

    Don B

  12. Allan M October 24, 2010 4:20 am #

    Hi Alan,

    Reading the Covered Call for LEAPS http://www.thebluecollarinvestor.com/blog/covered-calls-and-leaps-an-alternative-strategy/

    How will the assignment be handle in case the short Call is exercise (1) prior to expiration (2) during Friday expiration?

    Also, your statement :”Forced assignment may not allow for a profitable trade”. Can you elaborate this?

  13. owen October 24, 2010 11:34 am #

    Allan M, I think I’ll take a shot at answering you.

    If the short call is exercised, your broker may (ask them) call you and ask what you want to do. You can buy the shares that day to deliver, or they may exercise the LEAP to get the shares to deliver. It works the same with a same month spread.

    The reason forced assignment may result in an unprofitable trade is because you may have paid a time premium on the LEAP expecting that you could get a couple of different months short calls that expired during the LEAP’s lifetime.

    Owen

  14. Allan M October 24, 2010 2:46 pm #

    Owen (#13),

    Just check with my broker regarding assigment,

    For the standard CC:
    If you are short a call that is in the money ( stock price is higher than the option strike price) it would be exercised and the stock would be delivered at the strike price to the holder of the option.

    For a CC using LEAPS:
    If the calls are exercised and no long stock is in the account a short stock position will appear. The cost basis for this position should be the strike price + the options premium less the commissions. The position should appear in the account the day after the option is exercised.
    To view the cost basis of a positions go to your account statements.

    In this case, i don’t have a “forced assignment” on the LEAPS. But since I have a short stock position, i may loose on the bid-ask if i want to close the stock position afterwars, am i correct?

  15. owen October 24, 2010 3:37 pm #

    Presumably you bought a lower strike LEAP to act as a pseudo stock position. If the broker doesn’t automatically exercise you can do one of two things. You can tell the broker to exercise your LEAP and close the short stock out, or you can hold out and see if the stock drops.

    If you hold out for a stock decline you will lose money on the LEAP, so it would probably be best to simply exercise and close it out. That way you hit one of the possible outcomes of the original trading plan and you can move on.

    There actually is a third choice, buy the stock, close the short, and sell a new call option. That would be similar to a covered call where you got called away, but you still believe in the stock, so you buy the stock again and sell another call.

    See what I mean when I say this can get complicated? It’s sort of like juggling a plate, a fork and a rock. They aren’t the same, so you have to keep your eyes on all of them at the same time.

    As for your last question, the bid/ask difference was on the call. If the stock is called at $45, and you go out and buy to cover today, at $49.51, bid/ask isn’t really an issue.

  16. Dennis Hand October 24, 2010 4:59 pm #

    interesting subject regards the puts. I personally started using them myself after last January took a big dip and I saw my quality portfolio diminish in value. As much as I hate to cut into my profits with cc I’ve found what works best for me anyway, is I go way out time, wise on an O-T-M strike and just keep selling the monthly calls and I sleep peacefully knowing I’m protected in case of the worst.

  17. Don_B October 24, 2010 5:47 pm #

    Dennis –

    In #16, are you saying you go way out timewise by BUYING the puts? And, IF SO, are these OTM puts reasonably deep out as well?

    Don B

  18. Don_B October 24, 2010 6:00 pm #

    Anyone interested –

    There is a book out called “Put Option Writing Demystified” by Paul D. Kadavy. Good piece of work, seems to me.

    His point about using puts to enter a position in a stock cheaper than market seems very valid. In that case, one sells the put out of the money, when he/she hopes to own the stock. I have used that technique successfully. As Alan advises on cc writing, the stock itself seems to represent the risk. One difference I have observed, tho. In put writing, if one is not exercised, one does not bear that risk, as one does not own said stock – compared to the fact that in most cases of cc writing, one bot the stock for the express purpose of writing. Of course, if the investor ends up owning the stock while it goes lower than his put s.p. that is indeed a risk.

    Another thought – one can write the puts, be assigned, and then write the calls.

    FWIW.

    Don B

  19. Barry B October 24, 2010 10:37 pm #

    To Premium Members…Rev A of the report was just uploaded…a minor correction with CHKP.

    Barry

  20. Barry B October 24, 2010 11:40 pm #

    Premium Members…Rev B of the report has just been uploaded.

    Barry

  21. admin October 25, 2010 9:55 am #

    Allan (#s 14 and 15),

    Let me expand a bit on Owen’s excellent repsonse. When your short call is exercised, your brokerage will deliver the shares to the option holder thereby creating a short stock position in your account. You will have until the next business day to rectify this matter. This can be accomplished in one of two ways:

    1- Purchase an equivalent number of shares at current market price or….

    2- Exercise the LEAPS and purchase at the strike price on that option.

    Needless to say if you notice that your short call has a good chance of exercise, you could also buy back the short call or roll it out to avoid exercise. As Owen commented, matters could get a bit complicated. I strongly urge you to check with your specific brokerage to confirm how such trades are handled.

    My team and I have noticed that there is some interest by many of our members in some of the more sophisticated options strategies. This site is dedicated to the average retail investor and will always strive to keep things as simple and lucrative as possible. However, we are also responsive to the interests and needs of our members. As a result, we have decided to embark on a project after the new year to write another book and create a new DVD series that will include put options in our arsenal. As always we promise to keep it simple, understandable and geared to our group, average Blue Collar Investors. Once my third book is published (within the next few months) this new project will begin. Thanks for your feedback and guiding us in the direction that meets your needs.

    Alan and the BCI team

  22. Dirk October 25, 2010 10:50 am #

    @ Barry B
    thanks for the updated report.
    Why did you drop Checkpoint Software?
    All indicators look o.k. but declining volume.

    Cheers
    Dirk

  23. Jorge October 25, 2010 2:55 pm #

    I’ve been doing really well with RVBD the past few months and today its up $2. You can still get 3.5% with protection with the $55 strike price.

    Good luck.

    Jorge

  24. Dave October 25, 2010 4:17 pm #

    I’m also curious about Dennis’ post (#16). Wouldn’t the cost of the put increase as you go out in time?

  25. Barry B October 25, 2010 4:44 pm #

    Dirk (#22),

    I didn’t actually drop CHKP, I just moved it to the “Mixed Data …” I did that because the top section is for stocks that passed EVERY screen. CHKP had an n/a (no data available) for the Risk/Reward screen. Otherwise, it passed all of the other screens. the top green section is reserved for those stock that pass ALL screens.

    Barry .

  26. Don_B October 25, 2010 9:23 pm #

    On the ETF listings, I am wondering why there is no section for Precious Metals, or miners listed with the nine?? I do note that there is one for Materials – perhaps that is supposed to cover the PMs?

    There is one called XME available which I checked out – looks like the stochastics, the MACD, and the position of the 100 day/20 day EMA seem desirable. Also, the price relative to the above seems positioned well.

    Don B.

  27. Dirk October 25, 2010 5:25 pm #

    @ Barry B
    thanks Barry, I found it already in the “Mixed Data” and tried to to see the scouter rating.
    Nothing there.
    Any idea why?

    Cheers
    Dirk

  28. owen October 25, 2010 5:28 pm #

    Dave, Re #24,

    The answer is yes, the premium does increase the further out you go, but Dennis is counting on keeping the put, keeping the stock and selling a covered call each month. That way he can use the profits from six, eight or ten month’s covered calls to make up for the premium on one put.

    Also, you have to remember what out-of-the-money means in terms of a put. If I buy 100 shares of a $53 stock and sell a $55 strike covered call that is out-of-the-money for the call option. If I turn around and buy a $45 strike price put option, that is also out-of-the-money, becuase it works in reverse to the calls. If I can sell the stock for $51, why would I exercise a put to force someone to take my stock at $45?

    What Dennis is doing is simply limiting his downside by saying, “I’m willing to lose the $8 between $53 and $45, but no more. If the company suddenly gets sued for setting fire to 30 children, I can’t lose more than the $8 difference.” In the meantime, the out-of-the-money put will have a fairly small premium if the stock has been a steady climber for the last two or three months. Yes, the premium for the Mar 2001 $45 put will be higher than the Nov 2010 $45 put, but I will pay it once and hope the stock doesn’t drop.

    If my stock gets called, I will have three choices. Keep the put and buy the stock again to sell more covered calls, sell the put for a loss, or keep the put and hope the stock drops.

  29. owen October 25, 2010 5:31 pm #

    Sorry, that should be the March 2011 put, not the March 2001 put, in my next to last paragraph above.

  30. Barry B October 25, 2010 5:44 pm #

    Dirk (#26),

    I don’t have any idea as to why some companies are missing from their database. Even though Alan’s rules do not rule them out just because they didn’t appear in their database, I always move those stocks to the Mixed Data section if they pass the other screens. Only the best of the best appear in the top section.

    Barry

  31. admin October 25, 2010 6:19 pm #

    American Depository Receipts:

    These are foreign companies that trade on US exchanges. The MSN Scouter site does not rank these stocks. CHKP has its home base in Israel although a huge international presence in the US and Latin America. This would explain why we can’t get a risk-reward ranking for CHKP. Since it meets all other system criteria, it remains a candidate for 1-month covered calls.

    Alan

  32. Dirk October 25, 2010 10:19 pm #

    @ Don_B
    your # 31
    Sorry, but I can’t see this. . .
    MACD crossed downwards on the 18th, Stochastics went down at the 18th from the 80th to the 40th and the volume is declining.
    The only indicator up is the 20 day EMA.

    Maybe I see it wrong, then please correct me.

    Cheers
    Dirk

  33. Dirk October 25, 2010 10:26 pm #

    To my # 32
    This is a 6 months chart with 20/100 EMA

    Cheers
    Dirk

  34. admin October 25, 2010 10:34 pm #

    Don (#31),

    You are correct- XLB- materials is what you are looking for. On the premium ETF report click on the ticker and it will take you to another page which will give information on that security:

    http://www.sectorspdr.com/eqsnaps/?do=snapshot&symbol=XLB

    Alan

  35. Don_B October 26, 2010 12:12 pm #

    Dirk – #32

    No, you are not seeing it wrong. But I must add here a comment that the stochastics going down may not be a bad thing. Doesn’t that mean that the high numbers show overbought, and that going down means heading towards oversold, which in turn means buying is possibly in its future? Or have I turned these two around? On Volume, if red is net sellers and green is net buyers, then the volume is not that bad. Help me out here if I am wrong on these assumptions. Oh – I like the way you put that chart on the blog here.

    Anyone, on these items?

    Don B

  36. Dirk October 26, 2010 1:21 pm #

    @ Don_B
    Imho, the volume shows for the last week more selling than buying and the volume overall is declining.
    That is bad sign for me (just me) :>)
    The stochastics and the MACD show a real downtrend.
    Overnight the stock lost quite a bit, but gained it almost back up to early afternoon.
    When you look at the attached 10 day chart, you see a definitive downtrend.
    But this does not mean, that this will not be a great buy in the near future.
    Maybe the big guys selling it for whatever reason they might have.

    Cheers
    Dirk

  37. Don_B October 26, 2010 4:44 pm #

    For Dirk #36 – or anyone –

    You inspired me to make still another comparison. I charted XLB, materials, comparing to XME , precious metals. They are almost identical – except recently, you are right, the XME took a plunge. It seems, also, to be somewhat more volatile, going by the usual percentages that comparison charts use. Wow!

    Oh,I do not know how to input a chart onto the blog, hence my verbiage.

    Don B.

  38. admin October 26, 2010 5:51 pm #

    FFIV:

    Up $5 after hours- blowout ER.

    Alan

  39. admin October 26, 2010 5:54 pm #

    Don,

    To upload a chart: Save chart or file to your computer (my docs, desktop etc) in .jpg format. Then click on “browse” in the comment box and click on the file you want to upload. When you “submit” your comment the chart will appear.

    Alan

  40. admin October 26, 2010 3:04 pm #

    FFIV:

    This stock was “bumped” from our premium watchlist for the first time in 6 months. Two weeks ago, it dropped 15% in price but has since recovered half that loss. Recent price action tells me that the market is anticipating a favorable ER after market close today. If correct, I wouldn’t be surprised to see FFIV back on our list in the near future.

    Alan

  41. Dirk October 26, 2010 8:27 pm #

    @ anyone,
    Alan’s advice in # 40 is correct and it presumes that your charting system lets you save the current chart.
    That’s unfortunately not always the case.

    The easiest way to do it, is with Windows-7.
    The snipping tool does the job for you.
    With Windows XP and Vista you could hit the “print” button, located somewhere in the upper right corner of your keyboard.
    But this prints the whole screen with everything on it to an Windows internal memory.
    From there you could paste it into a .doc or something else and then print it or save it.
    Pretty much stone age. . .
    The snipping tool in Windows-7 is located in: Start button/all programs/accessories.

    This has the advantage, that you are able to cut any piece of your screen or window out, save it as a .jpeg file on your desktop or somewhere else and upload it together with your comment, like Alan described above.
    E.g. see the cutout of my stockchart’s right side in my # 32 or my attachment to this comment. :>)

    Cheers
    Dirk

  42. admin October 27, 2010 10:31 am #

    Analyst downgrade:

    BJRI was downgraded this morning:

    BJ Restaurants (BJRI): The stock is reduced to Perform from Outperform at Oppenheimer, which says the current premium valuation fully reflects the company’s superior operating model and growth opportunities.

    This was after a recent stellar 3rd quarter ER where revenue was up 24% and an average 17% earnings surprise over the past 4 quarters. Its balance sheet showed $22M in cash with no long-term debt. This stock recently hit a new all-time high @ $35.34 but carries an expensive PE ratio of 44x forward earnings.

    Despite the downgrade this stock may be a good candidate for our portfolios.

    Alan

  43. Ed B October 27, 2010 11:56 am #

    Great topic this week. As I read the article and posts, you can see the complexity involved the more one tries to minimize risk or maximize return. Neither can be done completely. You have to determine what YOU want from your system. To use the strategies in this week’s article, you need to spend the equivalent of a full time job to execute the collar and other type strategies successfully. Most professional options traders I have spoken to over the years have relatively simple systems and are always net sellers of calls or puts.

    The BCI system as constructed allows for above average returns, and complex enough for risk minimization. We can never eliminate risk. That is mastering all various fundamental, technical evaluations and why exit strategies are so important.
    IMHO, Alan and the BCI team communicate a complicated topic in as simple terms as possible.
    The BCI system done right, can be as complicated or simple as you want.
    As Tolstoy said ” Where there is simplicity, there is genius”.

    Another saying, “With Options, you have options”. I think this came from a commissioned broker. More options, more commissions.

    From prior experience, I don’t think more options are necessarily better. Remember, every option or alternative requires a decision. In the stock and options markets many times those decisions are need to made quickly. You will probably have multiple stocks/options requiring decisions to be executed at the same time. So you need to know your plan and execute accordingly as conditions change for each position in your portfolio.

    I’ll keep it as simple as possible. I have all the ‘moving parts’ I can handle…Thanks BCI team.

    Ed

  44. admin October 27, 2010 1:00 pm #

    FFIV:

    One of the rules of the BCI system is: “never sell an option on a stock that is about to report earnings”. In some cases we may decide to hold a stock through an ER and, if positive and the stock still meets our system criteria, then sell the option. This will allow us to take full advantage of a positive ER AND the option premium. FFIV is a great example as was RVBD previously discussed.

    Many of our members emailed me (offsite) that they were holding this stock through yesterday’s ER. It has been one of the best performers from our premium watchlist over the past 6 months. Those who did were BIG winners…congrats. The stock is up $14 today. With 13 trading days until expiration Friday more cash is possible. Check the 110, 115, and 120 strikes. All have appealing returns with either protection or upside potential. Taking advantage of situations like this is what sets BCIs apart from all other cc writers.

    Alan

  45. admin October 27, 2010 8:34 pm #

    Golden Cross:

    Let’s combine our discussion of the golden cross from this week’s article and a stock mentioned in the blog commentary, CHKP.

    The green circle in the chart below shows the point where the short term moving average moved above the longer term MA. The red arrows show the share appreciation from $32 to $43, up 34%.

    Alan

  46. Chris October 28, 2010 8:03 am #

    Alan,

    I was one of your members who held ffiv thru the earnings report. I originally bought 200 shares for $100.51 and sold one Oct. 95 and one Oct. 105. 100 were sold @ 95 and I still owned the other 100 which I decided to hold thru the earnings. As market was closing yesterday it was trading @ 117 and I sold the Nov 120 for 3.90. Yesterday was a good day!

    Thanks.

    Chris

  47. admin October 28, 2010 12:02 pm #

    Thanks to Ed and congrats to Chris.

    CHKP:

    On October 20th reported an ER with a 7% earnings surprise and revenues up 17%. This resulted in a new multi-year high @ 42.06. The company is also buying back shares, a positive for investors. The balance sheet shows cash and equivalents of $439M with NO DEBT! It trades at a reasonable 18x forward earnings compared to its industry average of 24x.

    Alan

  48. Dirk October 28, 2010 6:28 pm #

    @Alan
    could you please elaborate on the “XY x forward earnings”?
    I heard this term often and have a clou what it is, but would like to have a good BCI explanation on it.

    Cheers
    Dirk

  49. admin October 28, 2010 6:37 pm #

    Dirk,

    P/E Ratio or Price-Earnings Ratio- A valuation ratio that compares the price of a stock to its per share earnings:

    P/E Ratio = Price per Share/Earnings per Share (EPS)

    If the previous 4 quarters of earnings are used, it is referred to as “trailing P/E”. If the expected next 4 quarters are used, it is called “forward P/E”.

    Most stats you will see me using on this site are based on expected or forward earnings.

    Alan

  50. owen October 28, 2010 7:27 pm #

    Dirk,

    I’m not sure if Alan took too much of a shortcut with his answer, so I will elaborate.

    Many times you will see stocks valued at 10 times their earnings (per share). Sometimes this is the last earnings per share, sometimes it is on the expected future earnings per share. So, if a stock earned $4 per share last year, and it is currently trading at $48, it is trading at 12 times EPS (10 x). If you look at 6 other stocks in similar businesses, and they are trading at 8 times EPS, you have to start wondering why the market thinks this one is more highly valued, or if it is OVERvalued, and thus, due for a fall.

    So, when Alan wrote above that CHKP is trading at 18 times forward (next year’s expected) earnings, and the other stocks in that industry are trading, on average, at 24 times next year’s earnings, you have to wonder if perhaps CHKP is a bit UNDERvalued and may have some upward room on it. Of course, the other stocks could be overvalued and CHKP is going to sit and spin, but that’s why they call it speculation.

    Just another one of those little tick marks you make to determine if this stock is a trade or a pass. Just be careful you are comparing trailing EPS to trailing EPS, or forward to forward.

  51. owen October 28, 2010 7:29 pm #

    Sorry, should be (12 x) in paragraph 2 above.

  52. admin October 29, 2010 6:42 am #

    Premium members:

    This weeks report on top-performing ETFs has been uploaded to your premium site. In the past 3 months these securities are up in value between 10% and 27% while the S&P 500 increased in value by 8%. Look in the “resources/downloads” section for the report dated 10/29/10.

    Alan

  53. admin October 29, 2010 11:58 am #

    BIDU:

    This company had a strong ER on October 21st with revenues up 76% and an average earnings surprise of 14% over the past 4 quarters. In the past year the balance sheet shows cash up $182M to $610M with NO DEBT! It is trading at an expensive forward PE of 78x but may be worth a spot on your watch list. It has been on our premium watchlist for 6 consecutive weeks.

    Alan

  54. Mark October 29, 2010 1:41 pm #

    Just did a mid contract exit strategy. Closed my 40 call on CHKP for a loss of 20 per contract or 80. Time value was near zero as Alan discussed. Then I bought soa and sold the 17.50 call for a 2.9% return with some protection.

    Love this stuff….

    Mark

  55. Dirk October 29, 2010 1:58 pm #

    Thanks Owen and Alan,
    that was very informative. Especially Owen’s more in depth interpretation.
    (Sorry Alan :>))
    Thing is, that the websites usually don’t tell you, if it is a trailing EPS or a forward EPS.

    I am learning every day. . .
    Yesterday I participated in a webcast, hosted by Brian Overby (TradeKing), about Options pricing.
    Two blisters on my fingers from writing and 4 Aspirins later I was happy to go back to Alan’s blogs and read almost the same stuff in a much more digestible manner.
    Thanks again Alan, for processing the material for the average BCI brain. :>)

    I think Brian is extremely knowledgeable, but I need a few more months here in the BCI family to understand and comprehend fully, when he rushes through the stuff.

    Cheers
    Dirk

  56. Don_B October 29, 2010 1:59 pm #

    Just want to know why there are a small number of strike prices available on the upside, OTM, in some stocks, while not so in others. Looked at several just now where there is only one S.P. available above the current market price, and that is within one dollar. How and when are the strike prices that are offered set in place? And then I wonder if this matter is of any real importance to me as a cc writer?

    Don B

  57. Don_B October 29, 2010 2:00 pm #

    PS – on my #56, I was looking at DBS and SIVR.

    Don B

  58. Don_B October 29, 2010 2:18 pm #

    Anyone holding BCSI from a higher market level than now, who would like some comfort, will find some in today’s Option Monster. Those who do not have that will find it at option monster dot com. It is free – they want you to give your email address and set up a password. They have not bothered me, ever, with pressure of any kind. Each day there is a page full of headlines of what they find going on in the option market. Very interesting indeed.

    For today, (stories change daily) look for “Blue Coat – a Lesson in price patterns”. Their potential target is to the $34 area. !!!

    Don B

  59. admin October 29, 2010 2:23 pm #

    Don,

    The short answer is that there is no interest in these strikes. DBS is a low volume security with little interest in options. SIVR shows no volume for the $25 call so why put in a $26? (that’s their thinking). Now if you want a $26 and you don’t see it, call your broker and he’ll arange to have a $26 added. Or call the CBOE directly and they will add a strike. They are there to do business and if you are willing to be a customer, it will be arranged. You will always see a strike listed if there is a market for it.

    Alan

  60. owen October 29, 2010 5:08 pm #

    Dirk, even if the website isn’t telling you it’s trailing EPS or future EPS, if you use the same website to pull up each stock they will probably be using the same EPS for each of them.

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