In 2002, BXM was developed by the CBOE (Chicago Board Options Exchange) in cooperation with Standard & Poor’s. This is a benchmark index that tracks the performance of a hypothetical covered call strategy on the S&P 500 index. Data on this index can be accessed as far back as 1986. The parameters for this index are as follows:
- Buy an S&P 500 index portfolio
- Sell 1-month slightly out-of-the-money call (SPX) options
- Hold until expiration Friday and then cash-settled
- Then a new 1-month, slightly out-of-the-money call is sold
Two major studies performed on the BXM concluded that BXM returns similar compound annual percentage returns as the S&P 500 index but with much less volaility:
BXM study by Callan and Associates
This was an 18-year study that determined that BXM returned annual percentages of 11.77% compared to the S&P 500 returns of 11.67%. However, BXM did so with a standard deviation (volatility) of 9.29% compared to the 13.89% of the S&P 500, one third less.
BXM study by Ibbotson Associates
This 16-year study concluded that BXM reurns 12.30% per year compared to 12.20% of the S&P 500 also with two thirds the volatility.
Advantages of using BXM to traditional covered call writing
- Less time management required
- Less cash required
- Instant diversification
Returns in the long run are quite similar to that of the S&P 500 but in bear markets BXM will outperform. Here is a 5-year chart of BXM compared to the S&P 500 from 2006 through mid-2011 which included the recession of 2008:
BXM vs. S&P 500 2006 - 2011
Although this time frame was an aberration as it included one of the worst recessions in US history, it is clear that BXM (blue) outperformed the S&P 500 (black) almost 3-to-1 (15% to 5%). generally speaking, in the long run, the returns will be similar.
Why the BCI system generates greater returns
- We are not required to hold every stock in the index. We can select the best performers
- We can avoid the risk of earnings reports
- We can utilize different strike prices, not only slightly out-of-the-money strikes
- We can initiate exit strategies, not simply wait for expiration Friday
Conclusion
BXM will mirror the returns of the S&P but with much less volatility. The BCI system will elevate the returns of BXM by implementing fundamental, technical and common sense parameters. Which approach is best for you is something only you can determine. Once educated, the right choice will be an easy one to make.
Where’s Alan?
I will be on vacation in Europe returning September 12th. Blog articles (Market Tone section will be limited) and the Weekly Stock Screen and Watch List will be published on their normal schedules. I will visit the blog as often as possible. My response to emails will be limited but I expect to catch up the week I return. Books and DVDs will be shipped also on the regular schedule. I have had a lot of inquiries about my third book. The publisher is putting the finishing touches on the artwork for the covers and I anticipate approving it shortly after I return. I will keep you posted via this blog and those on my email lists. Thanks for your interest.
Market tone:
IBD (as of 9-1-11): Market in a confirmed uptrend.
BCI: Cautious and defensive. I am still concerned about the mixed economic reports. The recent market action has been positive but a longer term confirmation will encourage a move from this posture to a more aggressive one. I am still favoring in-the-money strikes with low beta equities. A full version of market tone will return in 2 weeks after I return from my trip to Europe.
My best to all,t
Alan (still without power!)
Premium members:
This week’s abbreviated version of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site. Due to the hurricanne and subsequent loss of power (still not on!) the usual graphics could not be included.
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
From John posted on previous article:
Alan,
Can you explain why hibb is listed as inconclusive on your stock list Thanks.
John
John,
HIBB has strong fundamentals but the recent market downturn has caused the short term moving average to dip below the longer term 100-d ema. This is to a great extent the result of market forces rather than individual corporate issues. Recently the 20-d ema has moved up (despite yesterday’s price decline) and once it crosses the 100-d ema, a bullish signal will be established.
Alan
Why does the CBOE select only out of the money strikes? There must be a reason why.
Barbara
Barbara,
The CBOE does not explain the rationale on its website however this is the most common strike sold by covered call writers and is a good simulation and representation of market activity at any given period of time. Of course, Blue Collar Investors may have other ideas. As I stated in the article, this IS one of the weaknesses in the study.
Alan
Premium Members,
The Weekly Report for 9/2/11 has been uploaded to the Premium Member website.
Best,
Barry
Alan, Barry,
Should we be avoiding the stocks listed in the “data inconclusive” category.
Thank you,
Dennis
Have a great timer in Europe – we’ll miss your insight. Wish we were there
Fascinating, and really telling, that eight of the nine stocks in this week’s new release of our weekly happens to be in the precious metals sector.
Seems to me that it bears watching!
Don B.
Hi to all our friends,
Cruising from Spain to Italy. Finally got a few moments to check in.
Dennis: Many of the “inconclusive stocks” are showing a short-term moving average trading UNDER the longer term moving average. I like to wait for the bullish crossover signal.
Thanks to Frank and all off-site well-wishes…wish you were here too.
Great to hear from Don!
Alan
Dennis (#7),
The BCI system is a ‘momentum’ system. Ideally, we like to see the price and moving averages stacked . That is…the entire price bar/candle above the 20 EMA, and the 20 EMA above the 100 EMA. Although a stock may meet all of our criteria, if the 20 EMA is below the 100 EMA, the stock is showing some short term weakness.
Moving average crossovers are an important technical indicator. So when the stocks that are in the “inconclusive” category and later have their 20 EMA cross over and above its’ 100 EMA, that is a bullish signal. Assuming that the stock or ETF passes all the other screens, it becomes a candidate for your consideration.
In the past Alan and I discussed what to do in situations like this and recently decided to set up a separate category for these stocks on the “Running List” so they can be tracked.
I hope this helps.
Best,
Barry
Don B (#9),
You might want to consider the ETFs “GDX” and “SIL”. These track the Gold miners and silver miners respectively. With GDX and SIL we eliminate any headline risk that can be a problem with individual stocks. As long as we have the political and geopolitical problems on going, GDX and SIL may make sense if you are interested in the precious metals sector.
Best,
Barry
Can anyone recommend a low cost brokerage. I’ve been told to look at Interactive. Anyone with experience with this broker?
I’m just starting and would appreciate any help.
Ellen
Ellen (#13),
Before changing brokers, you might first try to negotiate better pricing with your current broker. They most likely would give you better pricing than have you go to another broker. If that doesn’t work, look at the brokers that are more options focused…that is, have better options tools. These brokers are:
-Think Or Swim (now part of TD Ameritrade)
-Options Express (now part of Schwab)
-Trade Monster
All of the above have great options tools and knowledgeable brokers should you need adsditional help.
Best,
Barry
Ellen,
On your #13. You might consider having a look at Fidelity. They are low-cost, certainly, and their service is excellent. This of course refers to on-line advice, but there is one who is always assigned to a broker, who is knowledgeable. If the broker a person is assigned to is busy, there is always a knowledgeable one available. Just a thought. Good luck.
Don B
Barry and Don,
Thanks so much for your responses and advice.
Ellen
To our friends,
I wish for you all an experience like Linda and I are having cruising Europe. Barcelona, Florence, Vatican City, Pompeii and Sorrento are breathtaking cities that provided an experience words cannot describe. Palma Majorca will be our last stop and then back home to the real world. I hope this posting finds you well and you are keeping our stock market somewhat sane. I’ll catch up on emails the week of the 12th.
Our best to all.
Linda and Alan
Alan & Linda –
Your visit is reminiscent of ours, perhaps 15 years ago. Of the cities you mentioned, we visited Vatican City as well as Pompeii. Not to mention Rome, of course, and Turin (Torino). Fabulous places all. We do envy you and enjoyed your visit vicariously! Come home safely.
Don B. (& Nancy)
Anyone who has been using the BCI system for a few years willing to share their annual return rates?
Alan – have you ever asked for this information from your subscribers as to gauge this strategy against others?
Of course I’m referring to calculations which take into account losses due to the underlying stock dropping and (possibly) selling due to trailing stops. Also, I would think such a calculation would take commissions into account (and even the $29.95 monthly expense to BCI?)
I think I remember Alan stating that he had a 15% loss in 2008 (not positive about this!), and I sure would be interested in other figures for other years.
Thanks,
Mark
Hello Mark, (#19) –
I imagine most of us could only give an estimate of the success of the system. This may be due to the fact of, I bet, most of us merging Alan’s method with other fore-knowledge. Hard to visualize changing to ONLY one system, no matter how good. Habits of the years and what have you. Of course I can only speak for myself.
FWIW. Good luck!!
Don B.
Alan-
I’m a bit confused.
I bought NFLX at 132.23
Sold the 1 month 105 call for 30.89
Intrinsic value= 132.23 – 105= 27.23
TV= 30.89 – 27.23 = 3.66
Yield= 3.66/ 101.34 (actual cost) = 3.6 %
The stock drops to 113.27 and thus lost 18.96
The 105 call is now 14.45
New intrinsic value = 113.27 – 105 = 8.27
New TV = 14.45 – 8.27 = 6.18
Are my calculations correct, and why did the TV
rise with time? Doesn’t the intrinsic value of the option change dollar for dollar with the change in stock price or is the delta invoved. The large calculated change in TV seems odd.
If I close the position now, buying back the option and selling the stock–I lose 2 dollars per share. So I’m not fully protected during the life of the option. Only if the price stays above 105 at expiration. Right?
Thanks for all you do for the little guys.
Mike
Mike,
I can’t tell you how good it makes me feel when our members ask such sophisticated and pertinent questions.
Let me first review for our members what your trade represents: You sold a deep, deep-in-the-money strike that generated a nice 1-month return and gave you significant downside protection. Now my responses:
1- You calculations are near-perfect by the BCI methodology, perfect when using conventional cc calculators. When I calculate the ROO for an I-T-M strike (105), I use the time value only as the initial profit and use the intrinsic value to buy down the cost basis to $105, not $ 101.34. That changes the ROO from 3.6% to 3.5%.
2- Time value rising with time: This makes perfect sense because the stock price is dropping in value. TV of premiums approach zero the deeper in-the-money the strike is. As the market price drops, the strike is “less in-the-money” and therefore the TV rises. Out-of-the money strikes, for example, consist only of TV. In other words, the option premium is giving us more TV but less protection (IV). These are the pros and cons of different strikes that I talk about in my books and DVDs.
3- Option premium (not just the IV compnent)changes nearly dollar for dollar in-the-money strikes. Option premium dropped by $16.44 while the stock price declined by $18.90. Delta does play a role here as the closer to “1″, the more precise the relationship will be to 1-to-1.
4- You are never fully protected when dealing with stocks and options. We are being paid for the risk involved (in the stock). That is why one of our mission statements is to minimize risk and be prepared for exit strategy execution.
5- As it currently stands, your 3.5%, 1-month return is protected as long as the stock remains at or above $105. Your breakeven is $101.34.
6- There are no “little guys” in the BCI community…only VIPs!
I will re-publish this Q&A by this week’s article.
Alan