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Using Leading Economic Indicators in our Covered Call Decisions

Here’s my take on the economy and how it influences our covered call decisions: In a healthy economy, stocks are more likely to appreciate in value and we can then take a more aggressive posture with our investments. This means selling more O-T-M strikes and generating even higher investment returns. If we are experiencing economic woes as we did in 2008, we either must move our cash out of the market or take a more defensive posture by selling I-T-M strikes and perhaps not be fully invested.

In updating the economic situation, I have been summarizing the past week’s  ecomonic news and providing graphs of the S&P 500, the CBOE Volatility Index and other Industrial charts. This site has commented frequently about the economic indicators and whether the reports were positive or negative. Many of these figures came from The Conference Board and I can just envision many of you thinking to yourselves (as I have): Whoa….way too much information, it’s giving me a headache! So, I did a little research in an effort to encapsulate and simplify some of these stats.

The Conference Board:

This a a not-for-profit, non-governmental organization for businesses that disseminates information about key economic variables. These business cycle indicators can be broken down into three categories:

1- Leading Indicators: These are economic factors that change before the economy starts to demonstrate a particular trend. These indicators are used to predict future behavior of our economy. Here are the 10 indicators in this group:

  • vendor performance
  • interest rate spread
  • stock prices
  • real money supply
  • index of consumer expectations
  • building permits
  • manufacturers new orders for non-defensecapital goods
  • average weekly manufacturing hours
  • average weekly initial claims for unemployment insurance
  • manufacturers new orders for consumer goods and materials

An increase in the Leading Economic Indicators Index (LEI) bodes well for the economy.

2- Coincident Indicators: These are economic factors that vary directly and simultaneously with the business cycle, thereby describing the current state of the economy. The four indicators in this group are:

  • personal income
  • manufacturing and trade sales
  • industrial production
  • employment

This index paints a picture of the current economic environment.

3- Lagging Indicators: These are economic factors that change after the economy has begun to follow a particular trend. Just like moving averages, they are used to cofirm long-term trends but cannot predict them. The seven components in this group are:

  • average duration of unemployment
  • commercial and industrial loans outstanding
  • change in labor cost
  • ratio of manufacturing and trade inventories to sales
  • average prime rate charged by banks
  • ratio of consumer credit to personal income
  • change in CPI (consumer price index) for services

A continuing decline in these lagging indicators demonstrate a negative economic trend. For example, if the CPI (most important measure of inflation) was above expectations, it would have a negative impact on stocks and bonds.

Although it is not necessary to turn ourselves into sophisticated economists, I believe that it is prudent to be aware of what the statistics are telling us, so we can tailor our investment decsions accordingly. Here is a link to The Conference Board’s Website:

http://www.conference-board.org/economics/bci/pressRelease_output.cfm?cid=1

 Stocks to consider:

I located 7 stocks that meet our system criteria, which can be added to my watchlist. Here are the aforementioned equities:

 

CTRN

DIN

EW

MFE

MDAS

MHS

NSH

 

Let’s technically analyze the chart for DIN:

 

DIN as of 7-14-09

DIN as of 7-14-09

1- The short term ema is above the long term ema, a positive.

2- The price bars are at or above the 20-d ema, a positive.

3- MACD is positive and the histogram just had a positive center-line crossover, a positive.

4- Stochastics moved above the 20% and has not turned back, also a positive.

5- We have volume confirmation of these technical indicators.

Based on fundamental and technical parameters, this would be a stock that I would consider selling options on (after the upcoming ER) as long as the calculations were acceptable.

Thank you, Thank you, Thank you:

My publisher informed me that my last book, Exit Strategies for Covered Call Writing immediately broke into its top 10 list of sales. As of Thursday both my books were listed as 1 and 2 in sales under the category of “Covered Calls” on Amazon.com. I am deeply touched and humbled by your support.

JOIN MY NEW MAILING LIST TODAY:

Most of my fellow Blue Collar Investors have opted-in to my new mailing list. I’m glad you did. Some have not and there are only a few more weeks left to do so. I am currently working on a major project that may benefit all those interested in covered call writing. Only those on my mailing list will have an opportunity to participate. Don’t miss out and sign up NOW if you haven’t already:   

/joinfrnds.shtml

As I mentioned last week, I am hosting a seminar in California this weekend and that is why this week’s article was published earlier than usual. I anticipate catching up with my email responses during the course of the week.

My best to all,

Alan (alan@thebluecollarinvestor.com)

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.

28 Responses to “Using Leading Economic Indicators in our Covered Call Decisions”

  1. Eric R July 19, 2009 8:55 am #

    Congrats on the success of your books Alan. I can speak from personal experience when I say you have completely changed my outlook and strategies when approaching the markets. I now have a great deal of confidence about the decisions I am making and your system has taken much of the emotion out of it. Thanks again!

  2. Barry Bergman July 19, 2009 10:51 am #

    Alan,

    Just a word of caution for the BCI team…

    A large number of IBD100 stocks that indicate that there are no options available for the stock, do in fact, have options available. This month I found that of the 29 or so stocks that were indicated as not having options available, do have options.

    Those stocks that have options available are: SXCI, HRBN, ORN, SYNT, BJRI, LL, ICVI, SNX, HGG, MDAS, SHOO, LINC, and ADVS.

    Barry

  3. Barry Bergman July 19, 2009 10:53 am #

    OOPS…I meant 13 of the 29…

    Barry

  4. Dave July 19, 2009 10:10 pm #

    Barry, thanks for the info on the stocks. Is there an easy way on IBD to tell if a stock is optionable? Or did you have to just look for the option chain on each?

    Alan, according to IBD, these stocks are not all green on the SmartSelect Ratings: EW, MDAS, MHS, and NSH. I thought in that case they would not be put on your watch list?

    Thx,
    Dave

  5. admin July 20, 2009 5:08 am #

    Dave,

    This article was written early last week as I was out of town this weekend. All stocks passed our system criteria at the time the blog was written but some may have changed since.

    Once a month I have Linda go through my watchlist and screen out those equities no longer meeting the system criteria.

    Thanks for pointing this out to us.

    Here is one way to determine optionable stocks from the IBD website; checking an options chain is another:

    OPTIONABLE STOCKS located from IBD WESBITE

    1- Go to the IBD Homepage

    2- Click on “Stock Research”

    3- Go to Options Center

    4- Scroll down to “Stock Lists”

    5- Click on “All options sorted by symbol”

    Here is the direct link:

    http://www.investors.com/StockResearch/OptionsCenter/reports/allstocks.aspx?reportType=2

    Alan

  6. admin July 20, 2009 5:48 am #

    To all BCIs who ordered books, DVDs and CDs through July 16th: All shipments took place no later than July 17th.

    Those orders received from July 17th through July 19th were shipped out this morning (July 20th).

    Thanks for your patience while my office was closed.

    Alan

  7. admin July 20, 2009 6:23 am #

    Hot off the press and related to this week’s article:

    “The U.S. index of leading economic indicators rose 0.7% in June, the Conference Board said Monday. This is the third straight monthly increase. The rise was slightly larger than the consensus forecast of Wall Street economists, who had expected a 0.5% rise. The gain is not as strong as the last two months. The index rose 1.0% in April and 1.3% in May. In the latest month, the coincident index fell 0.2%, while the lagging index fell 0.7%.”

    This along with Goldman’s announced bullish outlook on the S&P 500 for the remainder of the year has put the market in positive territory early on.

    Alan

  8. admin July 20, 2009 6:56 am #

    Historically, recessions have shown three distinct bottoms, technically. We have had two. However, these are unusual times times with TARP and the like and who knows if the third bottom will come.

    Analyzing the S&P 500 as it now stands, we would have a bullish outlook. In June the 50-d moving average crossed above the 200-d MA for the first time since the recession started in December of 2007. In past recessions, such crossovers have led to 19% gains in the market over the following 12 months.

    Technically, very encouraging but these are unusual times and who knows? That’s why I remain conservative with my in-the-money strikes.

    Alan

  9. Dave July 20, 2009 9:36 pm #

    Alan, thanks for the note and the link to the IBD options page. I went through the IBD 100 for the first time yesterday so I wanted to make sure I did it correctly. I did forgot about volume and had to drop 12 companies from my watch list today that were under 250K.

    I’ve found these companies that meet the fundamental critera and won’t announce earnings until after the next option period closes: QSII, ARST, ORCL, RHT, INFY.

    Also these companies announce earnings this week, so they may be candidates as well: CRI, AAPL, WIT, FFIV, CMG, INFA, NFLX, BJRI, STAR.

    Regards,
    Dave

  10. admin July 21, 2009 10:29 am #

    Dave,

    Excellent work, you’re doing a great job! A couple of other points to keep in mind:

    1- Published ERs dates can change. Make sure the report has been announced before entering into a position.
    2- Make sure you are adequately diversified by industry and cash.
    3- Use technical analysis to determine buy/sell decisions and strike selection.
    4- Use the ESOC to maximize returns.

    Keep up the good work.

    Alan

  11. Dave July 21, 2009 11:38 am #

    Alan, thanks again for the input. For these stocks: QSII, ARST, ORCL, RHT, INFY, the technicals look good except for QSII. I have a question about diversification though. Four of these stocks are computer software, but different IBD groups. Would you treat these as four different industries?

    Thx,
    Dave

  12. Dave July 21, 2009 12:00 pm #

    Ooops, forgot to list the 4 groups.

    COMPUTER SFTWR-MEDICAL
    COMPUTER SFTWR-SECURITY
    COMPUTER SFTWR-ENTERPRSE
    COMPUTER SFTWR-DESKTOP

  13. admin July 21, 2009 7:32 pm #

    Dave,

    The more your industries are related to each other, the greater your risk exposure. If your portfolio consisted of 5 stocks, I would select the best of these 4 and try to locate four others in non-related industries. If you had a much larger portfolio, I would have no problem owning two or more of thgese depending on the size of your holdings.

    In general, the more diversified your portfolio, the lower your risk and that’s what the BCI system is all about…minimizing risk.

    Alan

  14. admin July 22, 2009 4:54 am #

    We are currently in the heart of earnings season. Each day many equities will report some of which are on our watchlists. Stocks like AAPL, WIT, CMG and FFIV should be re-evaluated after the ER passes and if all system criteria are met, would be eligible for selling covered calls.

    Here is a link to see which stocks have or will report each day:

    http://moneycentral.msn.com/investor/market/earncalendar/

    Alan

  15. Mike July 22, 2009 2:53 pm #

    Alan,

    When writing about rolling up you usually qualify it be say sometheing like “on or near expiration Friday”

    There seems to be an increasing number of stocks with call strikes in $1.00 increments instead of $2.50 or $5.00. What is your opinion about rolling up in the first or second week if the stock price is up 2 or 3 strikes?

    Thanks for all your efforts.

    Mike

  16. admin July 22, 2009 3:02 pm #

    Mike,

    Most stocks that trade in the $25 to $200/share range will have options trading in $5 increments unless there was a recent stock split. Certain heavily traded equities (MSFT) and ETFs will trade in $1 increments and then your scenario may make sense.

    It will work if we can be assured that the security will go up and stay up by the end of the contract period. Here is where your risk tolerance plays a role. If you’re shooting for even higher returns, you may want to role up.

    For me, I now have both a great return and terrific downside protection of that profit. Since we are only obligated for 1 month, I do not take action but I tend toward the conservative.

    Great question.

    Alan

  17. admin July 23, 2009 11:00 am #

    A recent radio interview I participated in is being re-broadcast today (Thursday, July 23rd). To listen:

    http://www.MindYourBIZness.com

    Go to: listen to the program.

    Enjoy,
    Alan

  18. Dave July 23, 2009 12:29 pm #

    Hi Alan, I’m noticing that several of the companies that announced good earnings yesterday are up quite a bit today. I’m wondering if some of that optimism may wear off and it might be better to wait a few days before taking a position. Any thoughts on that?

    Thx,
    Dave

  19. admin July 23, 2009 1:03 pm #

    Dave,

    Pretty soon you’re not going to need me! That’s exactly what I do when a stock runs up after an ER.

    Alan

  20. admin July 24, 2009 7:12 am #

    A few of the stocks on my watchlist have taken big hits today as a result of disappointings ERs:

    INFA
    NFLX
    STAR

    I will re-evaluate the findamentals and technicals of these equities to determine whether these stocks no longer belong on my watchlist or perhaps may be great entry points for this month’s portfolio.

    Alan

  21. Dave July 24, 2009 3:12 pm #

    Hi Alan, could you give an example of how to calculate the 20% or 10% exit price for an ITM option?

    Thx,
    Dave

  22. admin July 25, 2009 5:40 am #

    Dave,

    There is no distinction between I-T-M, A-T-M, and O-T-M strikes in this regard. All situations are handled similarly.

    If you sell an I-T-M $50 strike for a stock you purchased at $52 and generate a premium of $3.50, you will buy it back @ .70 during the 1st 2 weeks of a 4-week contract cycle and .35 on week 3 of that cycle. You will buy it back at any price if you feel the need to sell the stock immediately (my Qualcom example in both books). Also, on or near expiration Friday, you can buy back the option at any price if the concurrent sale of the next months option makes for an appropriate investment.

    You will note that if you buy back the $3.50 option for .70, the intrinsic value portion ($2) is represented by .40 ($2 x 20%0 and the time value ($1.50) is represented by .30 ($1.50 x 20%).

    Therefore, using the same criteria for all strikes is both time efficient and accurate.

    Alan

  23. Joshua November 12, 2009 10:42 am #

    I am new to your site – can you advise what your way of picking stocks is – i can not find the particular article where you discuss this.

    i also would like to learn more about the technical analysis and how you pick the winners..any help is greatly appreciated.

    i went to Barnes noble today to check out your first book and they said its been out of print already. any ideas?

  24. admin November 12, 2009 11:55 am #

    Hi Joshua,

    Both of my books (best-sellers, I’m proud to say, on the subject of covered calls) are available in multiple venues. Amamzon.com and BarnesandNoble.com have them online through SAMR Productions. Your best bet is directly through this website:

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

    My first book, “Cashing in on Covered Calls” details my stock selection process and technical analysis system. You can also access (for free) the journal articles I have published over the past two years:

    http://www.thebluecollarinvestor.com/blog/

    On the left side of this page look for recent articles, categories and archived articles.

    Thanks for your interest.

    Alan

  25. Tom November 15, 2009 9:12 am #

    A month ago I wrote a cc on DSX (November $10 strike with $3 premium). It has now gotten completely away from me. Does it make sense to buy it back now for about $6.20 and write a December cc $10 strike for $6.30? That should carry forward my approximate $300 gain.

    On the one hand the shipping rates are going up, on the other hand DSX recently reported a loss.

    I will watch for a DSX weakening in the next month and may get out of this without too much damage.

    I discovered and subscribed to your service last week and your books are on order, maybe this won’t happen again.

    Thanks for your help.

  26. Rob January 4, 2010 7:27 pm #

    What does it mean if there is no scouter rating for a stock? I noticed that a few on the IBD 100 do not have a rating. If everything else is a go, are theses stocks possible?

  27. admin January 4, 2010 11:03 pm #

    Rob,

    Money Central does not rank most ADRs (American Depository Receipts). These are foreign companies that trade on U.S. exchanges. If the stock meets all other system criteria, it remains in consideration.

    Alan

Trackbacks/Pingbacks

  1. Types of Customer Orders plus Industry in the Spotlight - August 22, 2009

    […] News: _________________________ The latest round of reports suggest a slowly improving economy. The Conference Board’s idex of leading indicators was up 0.6% in July for the fourth straight increase. This suggests a bottoming of the recession. […]

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