beginners corner

The CBOEs Volatility Index (VIX)

In my books and seminars I discuss determining market tone before making any investment decisions. One of the main factors I utilize in this evaluation is the VIX.

The VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which is a measure of the implied or expected volatility of S&P 500 options over the next 30 days. This implied volatility is reflected in the premiums paid for the options.  It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk and is often referred to as the “investor fear gauge”.

There are three variations of volatility indexes: the VIX tracks the S&P 500, the VXN tracks the Nasdaq 100 and the VXD tracks the Dow Jones Industrial Average. 

The VIX is a useful indicator for short-term investors including 1-month covered call writers. Generally speaking, as market volatility increases the market values will diminish and vice-versa. The VIX is said to have an inverse relationship with the S&P 500. If we see a declining VIX or one that is remaining stable at a low level (below 30) along with an appreciating S&P 500, we have a favorable environment for selling covered call options. Here is a chart showing the inverse relationship between the VIX and the S&P 500 over a 3 month time frame:

Inverse relationship between the VIX and the S&P 500

 The red arrows highlight areas when the VIX was declining and the S&P 500 was appreciating and the blue arrows show just the opposite. 

Conclusion:

The inverse relationship between the VIX and the S&P 500 is not 100% accurate but it does add information that will help guide us in our investment decisions like strike selection for example. With a favorable VIX and a positive technical chart for the S&P 500 I am more likely to favor O-T-M strikes. I also may be inclined to roll out and up as opposed to just rolling out as an expiration Friday exit strategy. As with all other technical tools the VIX should be used in conjunction with other fundamental, technical and common sense indicators.

The ETF report has been enhanced (found in the premium site):

Each week the BCI Team screens exchange-traded funds (with options) from all asset classes and locates the top-performers over the past 3-month period. Of the remaining ETFs, the top 5 (greatest percentage 3-month appreciation) are charted along with the S&P 500.  Some weeks we will include more than 5. At the end of this report we now will also screen the S&P 500 Sector ETFs and chart the top 3 performers over the same 3-month time frame.

Select Sector SPDRs are unique ETFs that divide the S&P 500 into nine sector index funds.  They have the diversity of a mutual fund, the focus of a sector fund, and the tradability of a stock. Together, the nine Select Sector SPDRs represent the S&P 500 as a whole. However, each Select Sector SPDR can also be bought individually, providing you with exposure to a particular sector or industry group.

These securities all have options and can be used with our covered call strategy. Each week the BCI Team will do a 3-month technical analysis of the linear price chart of each sector and compare it to the performance of the S&P itself. The top 3 funds outperforming the market benchmark will be listed and considered to be among the best candidates for covered call writing in the near-term. 

The nine Select Sector funds are:

 
The Consumer Discretionary Select Sector SPDR Fund – XLY
The Consumer Staples Select Sector SPDR Fund – XLP
The Energy Select Sector SPDR Fund – XLE
The Financial Select Sector SPDR Fund – XLF
The Health Care Select Sector SPDR Fund – XLV
The Industrial Select Sector SPDR Fund – XLI
The Materials Select Sector SPDR Fund – XLB
The Technology Select Sector SPDR Fund – XLK
The Utilities Select Sector SPDR Fund – XLU

Here is the most recent chart taken from the premium site’s “resources/downloads” section:

Top 3 Sector ETFs

The BCI team will continue to make every effort to provide our members with the best and highest quality educational tools to achieve our goals of financial independence and becoming CEO of our own money.

Market tone:

This past holiday-shortened weekend produced some positive economic news. The U.S. trade deficit narrowed more than expected in July and the consumer debt decreased by $3.6 billion in July. The Federal Reserve noted “continued growth in national economic activity” but at a slower pace than hoped for.

A 3-month chart of the S&P 500 shows that the benchmark moved above the 50-d simple moving average in the beginning of September (red circle) and approaching the longer term 200-d simple moving average (green circle):

3-month chart of the S&P 500

 The 1-year chart shows that the market has been trending sideways recently and would show a significant positive technical signal if the pattern breaks through resistance on high volume (top green line):

1-year chart of the S&P 500

Summary:

IBD: Market in confirmed uptrend.

BCI: Cautiously bullish favoring I-T-M strikes.

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 three top selling books on the topic of selling covered calls alone. He is a dentist by day, a personal trainer, successful real estate investor, but he is known mostly for his profound stock option strategies.

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68 Responses to “The CBOEs Volatility Index (VIX)”

  1. admin September 11, 2010 11:51 pm #

    Premium members:

    This week’s “Weekly Stock Screen and Watch List” has been uploaded to your premium site. The ETF Report was uploaded on Friday.

    Alan

  2. Barry B September 12, 2010 10:46 am #

    Re: The S&P 500 chart

    Another pattern that can be seen and has been in the news recently is the” head and shoulders” pattern that has formed. When this pattern appears the possibility exists for a market drop. This does not always play out, but we should be prepared to act if it does.

    Barry

  3. Dirk September 12, 2010 11:03 am #

    Thanks again Alan for this valuable article.
    As a relative beginner, I have never heard about the VIX before and will include it in my research of course.
    What I am not getting is why there is an inverse relationship and how it should influence my decision for/against a certain stock/option.
    I thought that a high volatility drives the option premium up and this is in our favor. . .
    If your time allows, please give some more explanation on how we/I can interpret the VIX better and use it together with the other technicals to my advantage.
    Cheers
    Dirk

  4. admin September 12, 2010 11:51 am #

    Dirk,

    A low VIX or perceived future market volatility(under 30) is an indication of lower risk to many investors. This is why it has been named the “investor fear gauge”. When investors are more confident, they open their wallets and purchase equities.

    Now you bring out what seems to be a contradictory point and a good one: Isn’t greater volatility better for us as option sellers because we garner a greater premium? The answer in my view is absolutley not. Covered call writing is a strategy for conservative investors, not the “cowboys” (nothing wrong with aggressive investing if that’s your risk tolerance). We can generate great returns in a low volatility environment and be subjected to less risk than in a high volatility scenario. We can tweek are return potential by strike selection rather than highly volatile stocks. Those of you who read my first book (Cashing in on Covered Calls) may remember my “Taser” example.

    To summarize: When investors feel the security of a calm stock market they are more likely to purchase equities which drive prices up (supply and demand). The VIX is a tool that allows us the measure this investor sentiment. But it is only one of many tools that we use in the BCI system so I consider it important but not a panacea.

    Alan

  5. Dirk September 12, 2010 6:30 pm #

    Thanks Alan,
    this clarifies a lot.
    I was looking at it from the wrong angle.
    Glad that you pointed it out.
    And I don’t wanna be a “cowboy”. . .:>)

    If I had read your CCC book to the end, I probably would have known.
    But I am still in the first third and I used up already 1.5 high lighters and I am running out of red ink in my pen. Not to speak of the dozen sticky notes hanging out with remarks and hints on them. . .

    Cheers
    Dirk

  6. Barry B September 13, 2010 1:42 am #

    Dirk,

    You might think about getting the Kindle version as well. You can highlight with the Kindle version and in addition the the actual Kindle, you can download a free Kiondle reader for your PC. This will give you immediate access to the material while you are using your computer for covered call trading.

    Just an idea that will help you maximize the use of Alan’s material.

    Best,

    Barry B

  7. Jason September 13, 2010 7:51 am #

    Alan,

    Can you recommend a good site to create charts with more than one stock or etf for example like you do with VIX and S&P 500. Thank you.

    Jason

  8. Dirk September 13, 2010 9:38 am #

    @ Barry B,
    great advice!
    Downloaded the kindle version of CCC, played around with it and love it.
    Only drawback I see at the moment is, finding quickly the proper page.
    I would like to transfer my remarks and highlights from the paper copy on to the Kindle book, but they don’t provide page numbers.
    The location numbers don’t correlate to the page numbers.
    Other than that, nice to have and run it on my second screen.

    Cheers
    Dirk

  9. Barbara September 13, 2010 10:13 am #

    Alan,

    I noticed that the stocks on the premium watch list with very high dividends have low premiums. VGR is one example (7.8%). How much do you factor in dividends when making your decisions versus premiums?

    Barbara

  10. admin September 13, 2010 11:56 am #

    Jason (#7),

    Here is a free site for comparison charts:

    http://stockcharts.com/index.html

    On the top or right side of the page opt for “PerfChart” and type in the tickers you want to compare.

    Alan

  11. admin September 13, 2010 12:02 pm #

    Barbara (#9),

    The quality of the stock and its industry is the number one consideration when I make my investment decisions. Then I view the “common sense factors “(ERs etc) and calculations. If you like two stocks and one has a higher dividend yield, it would influence my decision.

    You will note also that in the premium report VGR as well as EPB have fabulous dividend yields and both are low beta stocks which traditionally will garner lower premium returns.

    Alan

  12. Don B September 13, 2010 4:19 pm #

    It seems we have quite an array of skills represented on this wonderful BCI blog site. What I cannot help but wonder is just how many lurkers, as they are called, are part of it!! If anyone wants to sound off, I, for one, would be please to read those lines. TIA.

    Don B

  13. owen September 13, 2010 4:49 pm #

    Don,
    Sometimes people feel they have nothing to contibute, and just read what others have to say. That’s not a problem. I have sat through several of Alan’s classes. Many of the students appear afraid to ask a question, but you can tell they want to. Then you often see a look of understanding come across their face when someone else asks the question and they hear the answer.

    It’s unfortunate. I have always taken the position that there are only two stupid questions: The one that does not get asked, and the one that gets asked again after it has already been answered. Alan’s classes, books and dvds are aimed directly at those with no experience, and, often, many questions and fears.

    If anyone is reading this, and you choose not to ask a question, or post a comment, we hope that we have answered your question. If we have not, PLEASE ASK. And don’t be afraid to ask a question which may have been answered six months ago on another blog entry. We do not expect you to read three years of posts to see if your question has already been answered, and there is probably someone who will read it and say, “I’m glad that person asked, because that’s what I was wondering.”

    Alan, and the other posters on this site, want you to succeed. The only way you can succeed is if you do something. You can guarantee you won’t fail if you do nothing, but you will also guarantee you won’t succeed, too.

  14. Amy September 14, 2010 1:53 pm #

    I just bought 200 shares of MELI for $74.05 and sold the October $72.50 options for $4.30. Using Alan’s calculator the option profit for one month is 3.8% and the protection is 2.1%. This looked like a good deal for a strong stock like this.

    Good luck .

    Amy

  15. Robert September 14, 2010 3:46 pm #

    Check out the October 15 and 16 options for tibx. Nice returns, great chart.

    Rob

  16. owen September 14, 2010 3:53 pm #

    Amy, do you have any other positions open right now? Alan suggests that you split your money, if you can, between several stocks.

    Andrew Carnegie once said, “Put all your eggs in one basket, and then watch the basket.” For covered call writing that’s not really the best choice.

    Vivus is a good example. It dropped from over $12 to less than $5 inside of fifteen minutes when the FDA turned down their obesity drug back in July.

  17. DaveD September 14, 2010 4:12 pm #

    Has the market reached resistance…

    The s&p500 chart says perhaps so…

    1) The last trading day was a doji
    2) The last 2 trading days were a harami cross (watch out!)
    NOTE: For those that have no idea what im talking about with points 1 and 2, im refering to candlestick patterns.
    3) We have reached this resistance level twice in the last few months and each time it went back down…

    Dave

  18. Amy September 14, 2010 4:54 pm #

    Owen,

    Absolutely. I usually have between 5 and 10 positions at any one time. I just posted one that I entered today. Good point though.

    Amy

  19. owen September 14, 2010 5:25 pm #

    Good for you, Amy.

    Interesting post, Dave, but I always keep in mind that the people who lined up for four days for an iPad, or Halo Reach, don’t know what a candlestick pattern is.

  20. Dirk September 15, 2010 10:33 am #

    @ DaveD,
    Could you please elaborate on your above note a little bit?
    Just for me and the ones who are not so familiar with those patterns. :>)

    Cheers
    Dirk

  21. Dirk September 15, 2010 10:39 am #

    @ All,
    I see some odd strike prices at VGR today. . .
    What is the significance of that?

    Cheers
    Dirk

  22. admin September 15, 2010 11:05 am #

    Dirk (#21),

    This is a great example of a contract adjustment due to an unusual event in this case a 5% dividend distribution. This resulted in the formation of non-standard option contracts. Here is a link to the CBOE article related to these contracts:

    http://www.cboe.com/publish/TTStockSM/10-492.pdf

    Here is a link to a related article I wrote earlier this year:

    http://www.thebluecollarinvestor.com/blog/stock-splits-how-they-impact-your-covered-call-contracts/

    Alan

  23. Barry B September 15, 2010 11:37 am #

    Dirk,
    re: Post #20

    A “Doji” is a Japanese Candlestick pattern that tends to show indecision by the market. It looks like a “plus sign”. Usually, when it appears at the top of a trend or a bottom of a trend, it may indicate a trend reversal (accurate about 70% of the time). Combine that with resistance at 1130 on the S&P, where the Doji appeared, may indicate a coming downturn…which is how I interpreted DaveD’s comment.

    Today, there is a small “Spinning Top” which also is looking like another “Doji”. So…there may be a change in direction coming. It is important to note that these patterns tend to be reasonably accurate. However, with all of the government intervention, US political situation, the world geo-political situation, and the international economic landscape…who knows what will happen. But Candlesticks tend to be a great indicator of market psychology.

    Barry

  24. Don B September 15, 2010 12:31 pm #

    In the NOT a dumb question category even after reading the CBOE link in #22 : I fail to grasp just WHY it was necessary for the VGR people to make that adjustment of 5% in contract sizes and strikes, just because they made a special dividend distribution!? TIA.

    Don B

  25. admin September 15, 2010 1:06 pm #

    Don,

    When a 5% dividend is distributed, the price of the stock will NORMALLY decrease by a similar amount. View it as a capital restructuring. Now if you bought a $20 call in hopes of a stock going up and the associated call option also appreciating how fair would it be to that option holder to have a 5% decrease in the stock value and an ensuing devaluation of the $20 call option? To compensate, the strike prices are reduced by a factor of 1.05 and the multplier increased by that amount. This way,
    it is fair to everyone on both sides of the trade. Non-standard options are specific to each situation. They are difficult to understand and generally should be avoided. If you hold a position with an option that has been adjusted, call your broker for a complete explanation.

    Alan

  26. owen September 15, 2010 2:28 pm #

    It’s not that they issued a 5% dividend, it’s that they issued a 5% STOCK DIVIDEND. What that means is that the 100 shares of stock, on which the option was written, is now 105 shares of stock. Because the option contract is still for 100 shares, they adjust the strike price to account for the fact that it is NOT precisely the SAME 100 shares originally agreed to.

    A stock dividend is the same as a stock split. Instead of “splitting” the stock 3 for 1,, or 2 for 1, they “split” it 1.05 for 1. Just as they do with a stock split, the options must be adjusted to account for this change. It is not a coincidence that $16.67 is equal to $17.50 divided by 1.05. Handy having a math whiz on this blog, isn’t it?

    A cash dividend equal to 5% of the capital would not be the same. The total number of shares would not change, and the percentage of the company represented by 100 shares would still be the same as it was before. In a stock dividend, 100 shares of stock no longer represents the same percentage ownership of the company.

    And, Don, it was certainly NOT a dumb question. It’s an excellent example of the odd things that can go on with covered calls, and a terrific opportunity to answer the question the lurkers haven’t asked.

  27. Barry B September 15, 2010 2:53 pm #

    Owen,

    Excellent…thank you.

    Barry

  28. Dirk September 15, 2010 3:56 pm #

    Hi Owen,
    If I understood the CBOE circular correctly, the strike price has been reduced by the factor 1.05 but the number of shares in an option contract for this company has been increased to 105 to compensate for that.

    Cheers
    Dirk

  29. Edward W. September 15, 2010 4:13 pm #

    Can someone tell me why the Qs have two sets of September options.

    Thanks.

    Ed

  30. Dirk September 15, 2010 4:55 pm #

    And btw., thanks Barry for the explanation. . .
    Unfortunately my untrained eyes can’t seem to see this particular pattern. . .:>)

    Cheers
    Dirk

  31. owen September 15, 2010 5:35 pm #

    The options for QQQQ: One expires Sept 18, the normal option expiration. The other expires Sept 30. Apparently it’s another index option, but I’m not sure why.

  32. admin September 15, 2010 6:04 pm #

    Ed and Owen (#s 29 and 31),

    There are a few heavily traded ETFs that, in addition to the standard monthly expiration contracts also have quarterly expiring contracts. These unusual contracts will expire at the end of the month in March, June, September and December. Many of the strike prices in these months will show different premiums for the same strike prices. For example, QQQQ may have two $45 strikes, one expiring on the third Friday and the other at the end of the quarterly trading month. The latter will show a slightly higher premium due to the added time value. Other ETFs that have quarterly contracts include SPY, DIA and IWM and others are expected to be added in the future.

    Alan

  33. owen September 15, 2010 7:05 pm #

    Thanks, Alan. There are end of the quarter index options traded on all the indexes, so having end of the quarter call options on the index ETFs makes sense. That’s where we get the “triple witching Friday” expression from, stock index futures, stock index options and stock options.

    Interesting. So, we can actually trade, along with the big boys (and girls), the end of the quarter pricing, too. I have to keep that in mind. The more I learn, the less I know.

    Happy trading, everyone.

  34. owen September 15, 2010 7:11 pm #

    Oh, shameless plug here, but I saw a discussion of Maria Bartiromo’s new book, “The Weekend That Changed Wall Street”, on the web yesterday. It’s about the players and the discussions during the weekend they let Lehman Brother implode. I promptly ran over to Barnes & Noble, and they had it in stock. I’m only twenty ages into it, but the greed, arrogance, indifference and stupidity she discusses are just startling.

  35. Barry B September 15, 2010 8:55 pm #

    One other observation of the VIX and Candlesticks…

    Yesterday the VIX printed an Inverted Hammer and today it printed a Hammer. Both of these were at the bottom of a trend. Normally, this combination of candlesticks, either at the top of a trend or at the bottom of a trend, indicates a trend reversal. In this case, it was at the bottom of the trend, so an uptrend is expected. However, these symbols were displayed on the VIX, which moves inversely with the market in general per Alan’s article this week.

    So…there may be a change in the market direction…to the downside. Again, no guarantees, but be prepared to use the appropriate exit strategies as necessary.

    Barry

  36. bruce September 15, 2010 11:24 pm #

    fascinating reading!

    lurker bruce

  37. DaveD September 16, 2010 3:54 am #

    MED

    If we bought the stock right now and sold the 26 call with only 1 day till expiration, we would have a deal that gives us 1.7% in 1 day!!!

    SHOW ME THE MONEY!!!

    Dave

  38. owen September 16, 2010 9:59 am #

    Dirk #28, yes, you are correct. I incorrectly stated that the contract was still for 100 shares. By reducing the strike by a factor of 1.05 you still get the same percentage of the company you originally contracted for in the option. So, as the option writer, you started with 100 shares and now have 105 shares. If you get called the option holder gets the 105 shares, so don’t try to sell the extra 5.

    Thanks, Dirk. My error.

  39. Dirk September 16, 2010 11:51 am #

    @owen, thanks for the clarification.

    @Barry,
    I did a comparison chart this morning to have a closer look at the closing of the VIX-SP500 gap.
    There is some tendency. . .you are right

    Looking at the last gap-closing starting at about August 9 continuing through August 24 when the lines crossed, it needed 14 days for that.

    So, if this continues like last time, then the reversal will be in full swing in the middle of our next covered call cycle for October.

    But who knows at these times, the gap might widen again like it did the last time on July 30.

    But very interesting. I am learning something every day. . .:>)

    Cheers
    Dirk

  40. Barry B September 16, 2010 4:00 pm #

    Dirk,

    That’s why we’re all here…we are a learning community…all growing together.

    Barry

  41. DaveD September 17, 2010 1:15 am #

    AMED

    Rght now we can buy the stock for 28.03 and sell a september 28 call for 54c…

    Thats 1.8% with 7 hours till expiration…

    Alternatvely we could sell the October 16 call (28 strike) and make a tidy 6.3%…

    SHOW ME THE MONEY!!

    Dave

  42. admin September 17, 2010 6:34 am #

    Today is expiration Friday:

    To those new to covered call writing if our stock price is above the strike price we sold for the September options, our shares will be sold over the weekend unless we decide to avoid this by executing a “rolling strategy”.

    For example, MELI is trading @ $73.74. Had we sold the 9/$70 call, that strike is in-the-money and our shares will be sold unless we take action. We take the following steps:

    1- Check to see if the stock still meets system requirements. Premium members will reference the last watch list published and see that it does.

    2- WE check the ER date and see that it is scheduled to report on Nov. 4th, beyond the expiration of the October contracts so it’s eligible for a rolling strategy.

    3- Use the “what now” tab of the Ellman calculator to see if the returns meet our goals. We can roll out or roll out and up. Here are the current calulcations (pre-market) for rolling out:

    B-T-C the September $70 call @ $3.80

    S-T-O the October $70 call @ $5.60

    ROO = $180/$7000 = 2.6%

    Downside protection = $374/$7374 = 5.1%

    This means that our 2.6%, 1-month profit is guaranteed as long as our shares to not decline in value by more than 5.1% in the next 1 month. You can also calculate the $72.50 and $75 strike prices.

    Alan

  43. admin September 17, 2010 9:02 am #

    PREMIUM MEMBERS:

    This week’s report of top-performing ETFs has been uploaded to your premium site. The posted securities have shown a 3-month share appreciation between 10-20% while the S&P 500 has been flat. We are also charting the top-performing S&P 500 Sector ETFs. This report is found in the “resource/download” section of the premium site dated 9/17/10. New members can learn more about our premium membership at the following link:

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

    Alan

  44. Dirk September 17, 2010 9:51 am #

    Quick question:

    In the calculator, what is meant by “upside potential”?
    I am talking about the “What now” tab.
    On the right side under “what if I roll out and up”

    Cheers
    Dirk

  45. owen September 17, 2010 10:16 am #

    When you sell a call option with a strike price that is higher than the current stock price you have the opportunity to pick up that difference as a profit.

    Say the stock is currently $38.75. You decide to roll out and up from the Sep $35 to the Oct $40. The new option will have an upside potential profit of $1.75, the difference between the current price and the strike price. You might have had an upside potential on the original trade, but that ship has sailed now that you are closing the current option and writing a new one. We look at the new trade as a new trade.

  46. admin September 17, 2010 10:20 am #

    Dirk,

    When you roll out AND UP, there are situations when the new strike price is higher than the current market value of the equity in question. Let’s say you originally sold the $80 call and the stock is currently trading @ $82. If you buy back back the $80 and sell the $85, that stock can now go up to and beyond $85 generating an additional $3 per share. It is potential income or “upside potential”. It is calulcated as follows:

    $300/$8000 = 3.8%

    If you rolled out and up to the $85 strike and the current market value was $86, there would be no upside potential but a slight amount of downside protection:

    Alan

  47. Dirk September 17, 2010 10:29 am #

    Maybe I am missing something. . .
    Besides the fact that the upside potential would be $1.25. . .:>)

    Potential means then, if the stock gets above 40 and I get called out, then I make 1.25 ?
    But if the stock lingers around the current price of $38.75 or bounces between $38.75 and $40, I will not get exercised and the potential remains a potential, right?

    Cheers
    Dirk

  48. Dirk September 17, 2010 10:40 am #

    Help from trained eyes!!!
    Would somebody, please have a look at ERIC?

    Since I am relatively new in the cc business I would like to have a second or whatever number opinion.

    The facts:
    I bought ERIC 1.5 weeks ago for $10.20, sold the Sep10 call for $0.77.
    The analysts opinion are of concern for me and when I look at the technical, it looks bleek too.
    What I see:
    200 EMA downhill, 20 EMA below the 200 EMA, MACD on the negative side, stochastics at zero and some good selling in the last half hour.

    Am I too negative or is it time to get out?
    Do you think, it will hold up to Monday, where I can sell the stock?
    I know, it’s a decision I have to make by myself, but here are so many pros and better trained eyes to have a look at this. . .

    Cheers
    Dirk

  49. Dirk September 17, 2010 11:03 am #

    @ Alan and Owen
    thanks to both of you. I got it now (hopefully:>))

    Alan, I saw your #46 after I wrote #47.
    Was on another screen.

    Cheers
    Dirk

  50. Dirk September 17, 2010 11:12 am #

    Me again, :>)

    When you look at the technicals for a potential stock to keep for the next month, which time frame do you chose?
    1 month or 3 month?

    Cheers
    Dirk

  51. Barry B September 17, 2010 11:58 am #

    Dirk,

    From my personal perspective…

    I look out one month…especially being on the lookout for an earnings report in the month that I am looking at.

    Barry

  52. Ed B September 17, 2010 12:38 pm #

    Question – Generally, for the BCI system and conservative investing approach, where our time horizon 1 month, what is an adequate downside protection %? I know it is subjective, but I have been using around 8% downside protection on positions. I use 8% based on William O’Neil’s (IBD founder) methodology, my historical stop loss criteria in longer term investing and because our basic stock screen is the IBD 100. This may be ultra cautious for our system, since we have exit strategies as conditions change within the month. If I used a 3-5% downside protection, my ROO would be higher and may be sufficient on a 1 month horizon.

    Any thoughts appreciated.

    Thanks,
    Ed

  53. admin September 17, 2010 2:45 pm #

    Dirk (#48),

    At 2:45 the stock is trading well above the $10 strike you sold. That means that the option will be exercised and your shares sold over the weekend for $10 and you will have made a nice profit. The question is whether you want to roll out to the next month. You do this if the stock still meeets your criteria for purchasing an equity, there is no ER next month and the calculations meet your goals. If not, let the big boys take the stock.

    Alan

  54. Dirk September 17, 2010 2:58 pm #

    Thanks Alan,
    the numbers look good so far, just all the technicals, I mentioned above in #48, are not nice in my humble opinion.
    And there is an earnings report on Oct. 22. . .

    Cheers
    Dirk

  55. owen September 17, 2010 3:15 pm #

    Dirk #48, there is no “wait until Monday” if the stock is at, or above, the strike price. It will get called on Saturday, Sep 18. If you buy back the option contract you will incur a trading fee and, if you decide to sell the stock on Monday, you’ll pay another trading fee. Why pay twice. let the stock go if you’re going to get rid of it. Close the option, and resell October, if you aren’t.

    Regarding your #47 query, the answer is yes. If the stock closes at $39.99 tonight, a $40 call will not be exercised. At $40.01 it may get exercised. At $40.05 it will get exercised, even if it’s by the other guy’s broker.

  56. Dirk September 17, 2010 3:21 pm #

    I am puzzeled a little bit.
    It happened now the second time, that I wrote a limit buy stock order very close to the ask price (Playing the bid/ask game) and it was not filled.
    I tried a market order then a few seconds later and it was filled even 2 cents below the bid. . .

    Just before I sent the order, I hit the update button on my stock software to make sure the price was still o.k.
    The bid showed …88 and I got it for …86

    Any explanation for that???

    Cheers
    Dirk

  57. admin September 17, 2010 3:31 pm #

    Ed (#52),

    I want to make sure you are comparing apples to apples. Downside protection in the BCI system is OF THE OPTION PREMIUM’S TIME VALUE or our profit. If you sell an option for $3 and it is in-the-money by $2, $1 is time value or profit and $2 is the downside protection of that profit. Your BREAKEVEN is $3.

    The 8% O’Neil is recommending (I believe, it’s been a while since I read his book)) is a stop loss placed below the price of the stock. This is well below the downside protection of the BCI system and 8% below the breakeven. When selling options the numbers are different from pure stock ownership because of the premium generated from the short option position. The amount of DP depends on your risk tolerance, market assessment and stock technicals. Unfortunately, one size does not fit all.

    Alan

    Alan

  58. Mike September 17, 2010 4:35 pm #

    Alan–

    What do you think about the buy-write trading tools found at most discount broker option platforms. They appear to treat the purchase of a stock and the sale of the call as a single transaction. The stock price minus the call value is the ” net debit” . These debit spreads are listed for each strike price. I can place a market or limit order on this value.

    I like to sell deep in the money options, and can quickly determine the value of the scheme, since the dollar gain is the difference beween the strike price selected (sale price) and the net debit ( cost). The %yield = $gain /net debit.

    Also the transaction is only charged one commission fee for both legs so you save about 10 bucks.

    Am I missing something or is it a good deal.

    Thanks

    Mike

  59. Dirk September 17, 2010 4:48 pm #

    Hi Owen,
    you are right, I expressed it wrong with the “wait for Monday”.
    What I meant was, buying back the option, wait until Monday or Tuesday for the stock to be a little bit higher and sell it then.
    I ran it through Alan’s calculator and it turned out not to be such a good deal.
    So, I decided to let it go, especially considering the fact that there is ER coming up on ERIC on Oct. 22
    I will lose the intrinsic value of $.20 but that leaves me still with an ROO of 4.3%
    And I am happy! :>)

    Cheers
    Dirk

  60. admin September 17, 2010 5:13 pm #

    Mike (#58),

    There are two ways of entering a cc position: “Legging in” or one step at a time which is the most common and “buy write combination forms” where you enter with a net debit and exit with a net credit. The latter is not offered by many brokerages. Here is a journal article I previously wrote on this topic:

    http://www.thebluecollarinvestor.com/blog/buy-write-combination-order-form-plus-charts-of-the-week/

    Alan

  61. owen September 17, 2010 5:19 pm #

    Mike, I thought I would offer my comment on your #58. I trade through Charles Scwab. I use the buy-write transaction screen, but only if I am willing to hit both trades at market price. If you set a limit price, the entire trade will be held up until both prices agree to your limit, and that may keep the trade from being executed. I would rather give (or take) $5 or $10 to get the trade done quickly, than to take the time to make sure I hit the price I want on both trades.

    As a CPA and attorney my time is what I sell, so I prefer to get the trade done and move on. That’s my opinion. For a retiree, or someone in Australia trading at 3:00AM, their time has a differnet value.

  62. Don B September 17, 2010 8:33 pm #

    I do buy-write regularly – Fidelity online does offer this. I am sometimes afraid to leg in one at a time, hence the b/w, using limit orders. Most times I am successful. Yes, saves commissions.

    What I do wish they would offer is the ability to BTC and then STO a new option on the same stock, in one fell swoop. Same reason.

    Don B

  63. Dirk September 17, 2010 11:16 pm #

    Don,
    I am using Active Trader Pro from Fidelity and never used buy/write.
    As a matter of fact, I did not even know, that this is available.
    How does this work out?
    Do the charge just the flat fee and treat it as one trade?
    Are you able to play the bid/ask game?
    So far, since I am new in the business, I just did a few trades and doing mostly paper trades and always bought the stock low and waited in a volatile morning to catch a higher premium.
    Meaning I was not able to get a stock at a good price and and sell an option for a good return at the same time.
    What is the secret to that? :>)

    Cheers
    Dirk

  64. Don B September 17, 2010 11:50 pm #

    Hi Dirk – your #63 . I use Active Trader Pro at Fidelity for research. Try going to your Fidelity.com, from ATP, then go to the appropriate account. Look down to the left side of your screen. You should find Trade Multi-Leg options. You enter the stock you intend to buy, then the proper option. Oh, be sure to check at the top to be sure you are in the account you want to be in – presuming you have more than one. I can indeed use a limit order. My experience has been that if the stock moves a nickel, so does the option, so the net debit is usually the same. I usually do not get left behind – tho of course that has happened. Playing the bid-ask game in reality can be done, just by adjusting your limit order. Oh, when you get filled, they show you the fill for the stock plus separately the fill for the option. I always check my History page, too. Spells out the amt bottom line. If you do these separately you pay that basic twice. Good luck. Hope this helps.
    Don B.

  65. Don B September 18, 2010 12:01 am #

    PS to my #64. Dirk, I am unable to handle the question in your last para. I.E., I don’t know the secret. All I need to know is whether or not I am satisfied with the return, per BCI teaching. That I determine before doing the B/W. In the final analysis I just determine before hand if the option premium is satisfactory. That is, I really do not have to care if I end up showing less gain on one and more gain on the other.

    Best of luck.

    Don B

  66. Mike September 18, 2010 1:25 pm #

    Hey Guys–

    Look like I opened a great dialog with buy-writes.

    Since I like deep in the money calls I go to any discount broker (Schwab, Fidelity, Ameritrade, Ineteractive broker) and go to advanced options. Call the broker if youre having trouble They will lead you through the usage of buy-writes on their trading platform.

    I get charged only one fee for the entire transaction. I have found it very helpful. I’m not interested in the limits on the stock or call –I only have to worry about the limit on the net debit. My trades go through rapidly ( as long as my limit is resonable) and if I got the net debit I wanted I’m happy. I don’t have worry about buying a stock and then finding that I can’t get the call price I want. It’s a single transaction and the debit may remain unchanged even if the stock or option price change.
    Fast , easy, and cheap. By the way, the most inexpensive broker I have found is Interactive Broker. It takes a bit of learning how to use their Trader Workstation, but it’s fast and inexpensive trading.

    It doesn’t solve the problem of selecting a stock–but I leave that up to Alan.

    Good Luck

    Mike

  67. admin September 18, 2010 10:01 pm #

    PREMIUM MEMBERS:

    This week’s “Weekly Stock Screen and Watch List” has been uploaded to your premium site.

    Alan

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