I sell predominantly 1-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 the 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 1-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, 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 chart below:
NETL 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 below:
The Ellman Calculator
Now, in the chart below, let’s examine the results of these calculations:
Option calculations
The ROO or 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.
***For a FREE copy of the Ellman Calculator and user guide send me an email @: [email protected]
Include your name and email address with the words “request Ellman Calculator”. The calculations are precisely the same as described in my books and DVDs.
Event update:
I will be presenting a FREE seminar on Tuesday July 12th @ 7PM for the Long Island Stock Traders Meetup Group. The topic is “Using Covered Call Writing to Increase Dividend Yield of High Dividend Yield Stocks”. You do not need to be a member of this club to attend. It will be held in a huge state-of-the-art auditorium at The Plainview-Old Bethpage Public Library (Enter building and look for the auditorium on the left):
999 Old Country Road
Plainview, NY 11803
Hope to see you there.
Market tone:
The jobs report on Friday created a negative finish to the trading week but the market response could have been a lot worse. Here is a review of this week’s economic reports:
- For the second month in a row there was a much lower than anticipated job creation
- 18,000 jobs were created compared to the 88,000 expected
- The Labor Department reduced the already low May figure of 54,000 to 25,000
- The ISM service sector stats expanded in June but lower than anticipated
- Orders and shipments of durable goods rose more than the Commerce Department expected as there was an increase for all factory orders
For the week, the S&P 500 rose 0.3% for a year-to-date return of 8%.
Summary:
IBD: Confirmed uptrend
BCI: Cautiously bullish starting to increase the percentage of out-of-the-money strikes but still favoring in-the-money strikes.
My best to all,
Alan ([email protected])
Premium Members,
The Weekly Report for the week ending 07-08-11 is now available on the Premium Members website.
Best,
Barry
Alan,
I noticed in the graphic of the three option chain months that the last trade is higher than the bid. Is this the result of playing the bid-ask spread you have discussed in previous articles?
Thanks.,
Fred
I am new member so please forgive me if this question has been answered previously. In this weeks stock list it appears that most of the stocks that passed the screens are not eligible because of the earnings dates. Is this accurate and how do you manage this situation?
Thanks for all the information.
Lori
Alan:
I note that one week options seem to generate the highest annual percentage return; they would also appear to provide the greatest degree of flexibility in dealing with the earnings date problem.
Since an increasing number of stocks have one week options available, I was wondering if you, or any of your contributors, have given any thought to implementing a strategy involving the sale of one week calls.
Thank you so much for all of your valuable advice. I have learned much from reading your
weekly posts, as well as the comments of your readers.
Ron
Fred (#2),
Good observation. This may be the product of “negotiating” the bid price as you suggest or the result of a time difference between the current published bid and the last trade actually executed. The main takeaway for us is the negotiate or “play” the bid-ask spread whenever the spread isn’t too tight (close together). In these scenarios we will oftentimes generate additional cash and the downside is to simply settle for the published bid… a no-lose situation.
Alan
Sure, the annualized returns are better for the shorter term option trades, however that assumes that the trade is repeated 12 times with the same conditions. “A bird in the hand is worth two in the bush.”
Same question as Lori. It appears as though there are only 9 stocks elegible for purchase for Aug expiration, and it’s too late to buy for July expiration. What do you do ?
I thought Lori and Bobby were mistaken since I’d looked over the first two pages of the report and saw nearly a hundred choices with “No earnings announcement this option month”. What is the utility of this statement when “this month” ends this week? Anyone more or less adhering to this weeks blog report is looking toward Aug 20 expirations. I think you should change the earnings Y/N column to reflect earnings reports in this, AND the next options month. Or maybe a separate column just for the next month, alongside what you have now. Any other ideas or opinions? This would save me much work, as I use the front page much more than the back page.
Lori and Bobbyg (#s 3 and 7),
As we approach another earnings season we are again faced with the challenge of a decreased stock pool. However, like most hurdles that face us there are some common sense solutions that will allow us to overcome them. Here are three resolutions we should consider:
1- We can turn to exchange-traded funds which are baskets of stocks and therefore will allow us to ignore individual earnings reports. Our weekly ETF Report will usually consist of at least 15 ETF covered call candidates.
2-You will note that the August contract consists of 5 trading weeks. That’s one of the reasons there are so many stocks on our watch list that report in this cycle. You will also note that the first 23 equities report in the first week of this 5-week cycle. We can let the ER pass, check to make sure that the stock still meets our system criteria (or check next week’s premium report) and then include these stocks in our “eligible” list.
3- Use a combination of the 9 eligible stocks, stocks that become eligible in the first week of the cycle and ETFs.
All three of these approaches represent conservative ways of circumventing what may initially appear to be a difficult problem.
Alan
Doug (#8),
Thanks for the suggestion. My team and I have actually considered reversing the format of the premium report where the “running list” (pages 4-6) would come first and the screening process second. We decided to leave it as is because we felt it reflected the BCI system as discussed in my books and DVDs…we run fundamental, technical and common sense screens and the formulate our watch (running) list. We have addressed the issue of earnings reports as it relates to each specific contract month by inserting broken black lines delineating one cycle from another as it relates to earnings reports. For example, in the screen shot below, the red arrows highlight the broken black lines that categorize stocks that are projected to report in the September cycle. I also highlighted those stocks in yellow.
When I print out the report each week I put the running list on top as that is the source from which I select all my stocks. The rationale for formatting the report the way we do is that it precisely follows the BCI methodology.
We do value the opinion of our members and thank you for your feedback.
(Click on chart to enlarge and use the back arrow to return to this blog)
Alan
Ron (#4),
Over the past 20 years I have traded various strike expirations both via paper and real-life trading and found that 1-month options (by far) have yielded the greatest returns. Weeklys are a relatively new product that may or may not prove to be useful to covered call writers as more stocks are associated with them. Of course, our trading parameters will have to be adjusted. For example, our 20-d and 100-d EMAs will not be appropriate as shorter time frames will need to be evaluated. For now, I do have two concerns:
1- The quality and quantity of stocks we have to chose from
2- The small window of opportunity we have to use our exit strategies to mitigate losses or enhance profits.
I would not shut the door on the possibility that these products may be useful to us in the future but I, for one, have not done the appropriate due-diligence to make that determination.
Alan
Lori, BobbyG, and Doug,
You might also look at the ER dates for the stocks in the Aug option month on the watch list. They are sorted by known info of when the ER dates will be. There will be 23 stocks reporting earnings during the first week with 7 stocks reporting during the first two days. If we then add them to the 9 stocks that you identified, we greatly expand the choices available. Since this is a 5 week option month, you should be OK.
Best,
Barry
Doug,
The column relating to “earnings announcements this month” is follows the BCI methodology precisely (per Alan’s post) and it focuses on the current option month that we are in. Since all of those 94 stocks have ER dates outside of the option month we’re in, I can see how your question would arise.
To address your other point, the number of stocks has grown. We originally started with the IBD100. This gave us a good pool of stocks that could be used with the system. Then IBD reduced the IBD 100 to the IBD 50. This reduced the pool of eligible stocks. Our subscribers were concerned with the number of opportunities that were available due to the editorial change. Alan then searched to find other sources of stocks that we could use the BCI methodology. Fast forward to this week…we now we have a much larger pool of stocks that meet the strict screening guidelines of Alan’s system. As a matter of fact, the number this week is the largest number of stocks that we’ve ever had pass all of our screens!
Best,
Barry
Lori, BobbyG, and Doug,
One point that I missed in my post…once we pass the ER date and the stocks still pass the screens, they become candidates.
Best,
Barry
Premium Members,
The Weekly Report has been updated and is now available on the Premium Users website. The ER Date for CHKP was updated this morning.
Best,
Barry
What are your thoughts on staying on the sidelines until the uncertainty in Europe and the debt ceiling issue is resolved.
All opinons appreciated.
Barbara
DLLR
Passed all screens this week but when I looked further I see open interest of 4 on the Aug 22.5 call and no other open interest. I seem to remember some guide lines for minimum open interest but can’t find it in the book. Can somebody refresh my memory.
Thanks,
Mark Tooker
re #17
I just found my answer under categories on the left side. 100 is a minimum guideline for open interest.
Mark Tooker
Barbara (#16),
Trading in a volatile market environment is a bit nerve-racking especially when you are relatively new to stock and option trading. There is no right or wrong answer to your question as it is a personal decision that should be based on your personal risk-tolerance. When I share with our BCI community that I employ in-the-money strikes and favor low-beta stocks but stay fully invested in most of these market conditions it is the right strategy for me but may not be for a more conservative investor. It is not unusual for me to get an email from one of our members asking me why I am so conservative in my investment approach and later that day another email suggesting that I am so aggressive. Different strokes for different folks. Find your comfort level and run with it.
Alan
NY seminar tonight:
I will be the guest speaker for the Long Island Stock Traders Meetup Group this evening. My presentation will begin about 7:15 and last about 1 1/2 hours. You do not need to be a club member to attend and the group does not charge an admission fee. The venue:
Plainview-Old Bethpage Public Library auditorium:
999 Old Country Rd. Plainview, NY
Alan
NFLX announced a new pricing model today. Up $3.
Happy trading.
Amy
Ron,
The biggest problem with the weekly options is the price of the stocks involved. The weeklies are mostly very high priced stocks. A true covered call for Netflix would require an investment of $29,400 for 100 shares. GOOG would take $53,500. If you have $300,000 to $500,000 those weekly options might be a choice. When you only have $25,000 or $50,000, you are forced to set your sights a bit lower.
UA:
This member of our premium watch list reported a strong 1st quarter earnings report in later April with a 21% positive surprise. Revenues increased by 36% year-to-year. Over the past 4 quarters UA has had an average 47% positive surprise leading to a new all-time high. The balance sheet shows $111M in cash with only $14M in debt. Our premium watch list shows an industry rank of “A”and a beta of 1.18 with the next earnings announcement due on July 26th. Check to see if this equity deserves a spot on your watch list.
Alan
Amy,
NFLX up $8 in pre-market. Good call.
Ted
Just remember this is a big earnings month. GOOG, AAPL, NFLX, RVBD, CMG all report in the next week, or two. If you consider trading them because you are convinced of a good earnings report, keep in mind a couple of things. The stock may still go down, because the earnings weren’t considered “good enough”, or that everyone had already run the stock up, expecting terrific earnings, and the first thing they will do the next morning is take their profits.
Alan,
When is it best to sell a stock that has an earnings report coming out in the beginning of August? Does it pay to roll out and sell it before the earnings?
Thank you.
Beth
Beth,
I sell my stocks after options expire so I can put the money to work as soon as possible.
Ted
Beth,
You asked specifically about early August earnings reports so I will address those first. July 2011 is unusual because the third Friday is actually tomorrow, so there is no reason to close a July call early. Even if the options expire on the 21st of the month (the latest the the third Friday can be) you still have more than two weeks before any following month earnings reports.
The “don’t hold’em” suggestion is simply because the stock may be subject to unusual swings that may cost you money if you hold it when the earnings are announced. For instance, watch the fun with Google tomorrow and Monday. It reports its earnings at 5:00PM tomorrow afternoon. The stock will probably rise, or fall, at least $10, maybe $15. It’s a volatile stock. We don’t know how much real information is actually priced into the stock. It may be similar for NFLX, AAPL and CMG in the next two weeks when they report earnings.
So, if you are holding a stock that will be called tomorrow, let it get called. Wait until after the earnings report to buy it again. If it does not get called, consider selling it before the earnings report comes out.
Owen and Ted,
Great advice as always. Thank you!
Beth
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
Ok, my mistake. GOOG reported earnings this morning and the radio reports it is showing it will rise $70 this morning. See what I mean by sudden changes?
Alan,
I noticed that the past few ETF Reports are screening with an RS rating of 60. Previously it was 70. Why the change and is it permanent?
Great service!
Paul
Paul,
Good observation. When creating the weekly ETF Report we use the highest RS rating possible that will generate a list of at least 15 great 1-month covered call candidates. Historically, that rating will range between 60%-70%. Recently many of the top-performing ETFs with options are leveraged funds which I feel are too risky for the conservative covered call strategy (they may be appropriate for those with higher risk-tolerance using other strategies). As a result our screen has been @ the 60% level as published in the report.
Alan
It was great seeing so many of you at my NY seminar this past Tuesday. I sincerely appreciate all the generous feedback.
Alan