I sell predominantly one-month options. This decision was NOT based on anything I read or was told, but rather on experience and common sense. Most stocks with options have at least four expiration cycles affiliated with them at any point in time…the current month, the next month and two more months further out based on the particular option cycle that particular equity has been assigned to. Stocks that also have LEAPS (long-term options) have more than four cycles. Using the options chains and the Ellman Calculator, I will make my case for selling mainly one-month options.
Three Reasons to Sell One-Month Options
1- It facilitates adhering to a core BCI guideline of never selling an option in a contract cycle that has an upcoming earnings report. Since earnings reports are made public on a quarterly basis for U.S. companies, selling short-term options allow us to move our stocks in and out of our portfolios (yet keep them on our watch lists if they still meet our system criteria).
2- Stocks have no loyalty to us. They can be our best friends one month and our worst enemies the next. Although we do have exit strategies to help control a negative situation (detailed in all my books and DVDs), the shorter the commitment we have to an equity, the less risk we incur.
3- We make the most money selling one-month options. I’m sure I have your attention now, so allow me to demonstrate via an options chain for Netlogic Microsystems (NETL), currently trading for $53.22 as shown in the figure below:
NETL- current price
The option chain is shown in the chart below:
NETL- options chain
This information was captured after the February contracts expired. We will hone in on the March (one month out), April (two-months out) and July (five months out) contracts. Here is the information we glean from the options chain and will feed into the Ellman Calculator (single tab):
- The stock is trading @ $53.22 so we will look at the $55 call options
- The March $55 call returns $1.65/share (red circle)
- The April $55 call returns $2.55/share (blue circle)
- The July $55 call returns $4.70/share (green circle)
It may be tempting to opt for the higher dollar returns of the longer-term options; however we must factor in the time frame and logically deduce how to best put our money to work so as to generate the most profits. So let’s feed this information into the single tab of the Ellman Calculator, as illustrated in the chart below:
The Ellman Calculator- single tab
Now, in the next chart let’s examine the results of these calculations:
Calculations
The ROO or initial percentage returns generated does NOT include the upside potential. Although the Ellman Calculator does give this information, I left it out of this graphic because all choices have the same upside, and I want to concentrate just on the initial option profit. Here are the ROO figures derived from the Ellman Calculator:
- The March $55 call returns 3.1% (green arrow)
- The April $55 call generates 4.8% (blue arrow)
- The July $55 call generates 8.8% (red arrow)
Once again, upon first glance it appears that the July $55 call will be the most lucrative for us until we annualize these percentages. To do so, we must convert these figures to a monthly return and multiply by 12, as follows:
- March: 3.1%/1 x 12 = 37.2%
- April: 4.8%/2 x 12 = 28.8%
- July: 8.8%/5 x 12 = 21.1%
The one-month options outperformed the two-month options by more than 29% and the five-month options by more than 76%! I rest my case.
Video highlighted on homepage– Multiple Exit Strategies for the Same Contract Period:
Market tone + Let me vent:
Are you as angry as I am about the way Congress is representing our interests? This past week, the Super Committee’s failure to come up with $1.2 trillion in budget savings over the next ten years was yet another breakdown by Congress impacting our well-being (it should not, however, affect the U.S. credit rating or the interest rates paid on Treasuries or their value). Like spoiled little children our representatives are putting their mean-spirited politics above the best interests of the folks. In our BCI methodology of screening for stocks, the number one screen is “are options available”. This is an essential requirement for covered call writing. It is so obvious that some of you have suggested removing it from the stock screen. Can we draw an analogy as to the first screen or requirement for selecting a Senator or Representative? How about having the ability to compromise and negotiate? Too obvious and simple to mention? Not any more in my view. Most members of Congress don’t pass the first screen! Our watch list of politicians can be counted on one hand. Why can’t they understand that they represent all the people not only those that agree with their every talking point? Derek Jeter thinks he’s worth $20 Million/year for 4 years. The Yankees think he’s worth $15 Million/year for 2 years. He gets $15 Million/year for 3 years and everybody is happy. Both sides were represented. This viewpoint may be a bit overstated as there are probably a decent percentage of fair, competent and hard-working members of Congress. The others need to go and quickly. This isn’t American Idol where we may vote for our favorite character. In the eyes of this investor, if you are a member of Congress and you can’t compromise and negotiate or simply won’t you must go… now. Then let them try to get a job and see what it feels like on the other side. Enough venting!
This holiday-shortened week’s economic reports were positive but muted due to the failure of the supercommittee, Europe’s debt crisis and the Fed’s announcement of future stress tests for 31 US banks:
- GDP was revised downward to 2% annualized (from 2.5%) however…
- 3rd quarter GDP was an upgrade from the 0.4% in the 1st quarter and the 1.3% in the 2nd quarter
- The revision was due to a decline in inventories which bodes well for 4th quarter production
- Corporate profits rose by 2.1% in the quarter much better than the 1% in the 1st quarter but less than the 3.3% in the 2nd quarter
For the week, the S&P 500 declined by 4.7% for a year-to-date return of (-) 6.2% including dividends.
Technically, the market tone is in negative territory. The VIX currently sits @ 34.47, well above our comfort level of under 30. The 6-month chart of the S&P 500 shows that the benchmark has dropped below its recent trading range support (green arrow):
S&P 500 as of 11-25-11
On a positive note corporate earnings continue to impress and December is the month that pensions are funded with stocks.
Summary:
IBD: Market in correction
BCI: The BCI is taking a neutral but cautious stance on the market selling only in-the-money strikes and favoring low-beta stocks and ETFs.
Hoping all our members had a wonderful Thanksgiving holiday,
Alan and the BCI team ([email protected])
Alan,
How would you apply the 20-10 rule for options more than one month out? Thanks.
Tim
I notice a lot of discussion of exchange traded funds on this site. Why not mutual funds?
Stuart (just learning)
Premium Members,
The Weekly Report has been uploaded to the Premium Member Website and is available for download.
Best,
Barry and The BCI Team
Stuart
I don’t think mutual fund have options?
Alan
I skipped last week because of the holiday and the wackos in congress – so with no stocks passing all screens what do you suggest – use the four best and one other from the failed list?
I’m having a problem with the weekly reprot – the margins are too small to print direct without trimming the test at the left. I downloaded the file and ran Adobe Reader and told it to fit to print area and it printed ok, but I can’t print directly from Chrome any longer.
If you can easily fix this great. If not I wanted to pass the fix along.
Tim (#1),
The 20% GUIDELINE would apply from the time the trade was executed through the first half of the final expiration month. At that point the 10% guideline would kick in.
Alan
Frank (#6),
The size of the report can be controlled at the top of the page (red arrow below). When printing use “fit to printable area” as shown in the screenshot below. Click on image to enlarge and use the back arrow to return to this blog.
Alan
Frank (#5),
With so few candidates passing our strict BCI screens due to the recent market decline we have an unusual dilemma for those entering new positions. One approach to consider would be to use one or more of the stocks with mixed technicals along with ETFs (from the report our team generated on Thursday). Additional protection can be generated by selling in-the-money strikes until the market begins to recover.
Alan
Alan
As usual, your article is both informative and provocative. Based upon all of the reasons why you favor one month options over longer term ones, shouldn’t one week options make even more sense (at least with respect to the somewhat limited number of stocks for which they are available)?
Thank you for all that you do for your followers.
Stuart (#2),
Frank is correct. If you are employing covered call writing as your investment strategy, you must use ETFs as opposed to mutual funds which have no options associated with them.
In general ETFs have certain other advantages over mutual funds. Here are a few:
Lower expenses (lower management fees)
Intraday trading (same as stocks)
May be more tax efficient
No minimum requirements
No redemption fees
Alan
Alan,
I am a new member and was wondering where I can find the ETF report you mentioned in your response to Frank. thank you.
Steve
Ron (#10),
The BCI team will be exploring the use of these products moving forward. My initial concerns are twofold:
1- Limited pool of stocks associated with weeklys (should improve as demand for these products continues).
2- Limited time for exit strategy execution.
Thanks for the suggestion and your generous remarks.
Alan
Steve (#12),
The ETF reports are located in the “resources/downloads” section of the premium site (right side of page). New reports are published weekly.
Alan
@ Frank,
Allow me to qualify this statement before I type. This is my first month to be a premium member. I read Alan’s book about a year ago and have been trading CC’s ever since. My record in that 12 months is about -1% APR. I pray (for my little girl’s college fund) that using this service will help my APR increase for 2012.
Having said that, EBIX looks to be on a nice run. I put in a pretrade order to buy stock @ $19.03 sell $19 STRIKE @ $0.90. 4.46% return if called out.
Good Trading,
Hud
Alan,
In your book about exit strategies you say a VIX under 20 is bullish. In your latest book and blog articles like this one the bar is raised to under 30. Why the change?
Thanks for your help.
Fran
Fran,
Market conditions and products have changed since 2007 when my first book was published. Our markets are now impacted by the global economy as well as other factors like flash trading, the expansion of derivatives and ETFs which have made the norm more volatile than in the past.
Alan
What is the bnest way to get updated information on the VIX? Thanks.
I just read a stat that corporate profits were up 6.5% in the third quarter above the 2.5% estimate confirming Alan’s comment about corporate earnings continuing to impress.
Good luck to all.
Amy
#15, Frank, I too have invested in EBIX from the recent list. I have 10 contracts @30cents with a ROO of 1.5%. If called away however I would have a upside potential of 5.1% and a total return of 6.6%. (annualized @ 133.8%).
Bought at 19.98 and have a strike at 21.00.
Don (#18),
Any site that offeres stock quotes will also give a quote for the CBOE VIX. Here is the CBOE site for quotes:
http://www.cboe.com/DelayedQuote/SimpleQuote.aspx
Enter “VIX” and then get quote. Some sites will require an entry of $VIX.
Alan
Unfortunately, my order for EBIX did not execute!!! Big buy on Monday morning squeezed out my order from Sunday night.
Today’s trade.
I bought ebix for 21.45 and sold the 21 option for 1.10. That’s a 3% 2 1/2 week return if ebix stays above 21. We need more days like today!
Good luck.
Fran
Yesterday’s huge bullish move in the market was much more than positive central bank actions. There also has been a load of positive economic indicators. These included a rise in new home sales, a positive ADP jobs report and most of all (as I have been reporting for months) record corporate profits. December is traditionally a positive month for the market so a rally through the end of the year would not surprise me. I still remain cautious (hello Europe) but fully invested.
Alan
Same store MONTHLY retail sales:
Today many of our “banned stocks” reported monthly sales stats and most did well. One great example of why we avoid these stocks in the BCI methodology is exemplified by what happed to Kohls (KSS). It posted a surprise drop in November same-store-sales and lost 7% of its share price at the time of this post. These monthly reports represent the same risk as quarterly earnings reports and in my view should be avoided. Premium members can find the complete list in the “resources/downloads” section of the premium site. It is also found in my first and third books. I’d also be happy to email you a copy:
[email protected]
Put “banned stocks” in the header and include your name.
Alan
Admin (#24),
Adding to Alan’s comment, the bulk of the big up move in the S&P, DOW, and NASDAQ yesterday (11/30/11) was in overnight markets. There was a big gap up at the open (approx. 392 points on the DOW) and most retail traders were not able to trade it…the move was in Asia and Europe overnight.
Best,
Barry
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:
https://www.thebluecollarinvestor.com/member/login.php
Not a premium member? Check out this link:
https://www.thebluecollarinvestor.com/membership.shtml
Alan and the BCI team
Alan
Could the BCI team do me a favor please? I’m just getting interesting in using the ETF report, but it is color coded. I am a bit color blind and can’t tell green from brown from red very well. (This problem afflicts about 10% of all men), Could you use dotted lines or put small notes at each line. It would help enormously.
Thank you
Alan,
On page 264 on your latest book you discuss closing your position if the “time value approaches zero”. Then using the cash to establish a second position in the same month. What would you do if that happened let’s say with only one week or a few days left in the contract? Thanks for all your help.
Tim
Frank (#28),
Thanks very much for pointing out this issue. Let me know if this information will suffice:
ALL charts are color-coded in the same manner:
Blue = best performer on chart
Green= next best
Brown = 3rd best
Purple = 4th best (Inverse ETF only)
Black = benchmark or S&P 500
All charts are color-coded in this same manner. See the chart below as further explanation. Let me know if having this information will suffice. If not, my team and I will try to figure out something else. Click on the image to enlarge and use the back arrow to return to this blog.
Alan
You missed the point – color blind means I can’t tell these colors apart – it is fairly common and makes the charts almost useless. If you use the arrows shown above or better yet different dotted and solid lines (with a list of how they are coded) that would work. Try printing out the diagrams in black and white and try to interpret them – that will explain the problem.
Thanks for all you do.
Frank,
I’m trying not to clutter the chart but will do what it takes to make this usable for our members with this issue. Let me add to my previous remarks:
Since the order is ALWAYS Blue-Green-Brown
best to worst, Blue will always be on top, green next and so on. Also, I provide percentiles so ITB in the screenshot is @ + 17%. Blue may be difficult to discern but since ITB is + 17%, it can easily be identified. Does this additional info help?
Alan
It’s hard to follow when they cross over each other – can you use dotted line for one, solid of another, solid with circle, solid with diamond – I believe this is all available in Excell. Any non-color differentiation that doesn’t clutter would be helpful.
I just did a sample chart in Open Office and when I included points it did what I need automatically. Can you chart program do this? I also sent an email with this so I could just paste in a chart – too much hassle to make a file and attach
Frank,
I’ll have my tech team look into this matter.
Alan
Tim (#29),
Whenever you can close a position with maximum profit (initial option return + share appreciation to the strike) at low or no cost (premium trading at parity or all or nearly all intrinsic value) the position should be closed. Now the question arises as to whether to use that cash to establish another cc position with that same cash in the same contract month. If you can generate 1-2% or more with a low risk investment, I say why not? If you can’t you can move to the next month or wait until the current month expires (my preference). In the example you alluded to in my new book, I generated an additional 2.2% initial premium profit which had a downside protection of 3.7% (chart on page 271).
Alan