The initial main step for covered call writers is to select the best underlying security. This choice will vary from investor to investor based on goals and risk tolerance. Some of our members prefer exchange-traded funds (ETFs), a strategy I use in my mother’s portfolio. ETFs offer the advantages of instant diversification, less volatility (in most cases) and less management time required. The main disadvantage is the lower returns generated by these securities because of the lower implied volatility and therefore time value of the option premiums.
To keep the process even simpler, some covered call writers will write calls against a broad market index ETF like SPY. This will give the writer exposure to the entire S&P 500 which historically appreciates 7-10% per year. As an example, I created a screenshot of the options chain for SPY with about 3 1/2 weeks remaining in the July, 2014 contracts:
With SPY trading @ $195.88, we will view the out–of-the-money $196, $197, $198 and $199 strikes.
We feed this information into the “multiple” tab of the Ellman Calculator to see if the results meet our goals:
With upside potential (share price moves up to strike price by expiration) the 3 1/2 week returns range from 0.9% ($196 strike) to 1.8% ($199 strike). The more bullish we are on the overall market, the deeper out-of-the-money strikes should be favored.
Now another, and perhaps even better, approach to this type of investing is to use the best-performing Select Sector SPDRs. These securities 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 500 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. We will also show a chart of all sector components. Below is a recent screenshot showing the 3 best-performing Select Sector SPDRs as of 6-18-14:
In the cases of both SPY and the Select Sector SPDRs, we have the advantages of exchange-traded funds as long as we are targeting the lower (but still significant) returns they generate compared to individual stocks. By using the SPDRs, we are limiting our exposure to the best-performers at any given point in time and can rotate in and out of them much like institutional traders do.
***For a free copy of the Basic Ellman Calculator use the “Free resources” link on the black bar at the top of this page.
Several members of my tech team have been working to upgrade the servers that support both the general and premium sites to accomodate the increased traffic (thank you for that!) we have been experiencing recently. This process should be completed sometime next week. Some of you have noticed slowdowns or downtime as a result of the site enhancement and I want to express my apologies for that but feel it will ultimately create a stellar site experience for all our members. Thank you for your support and understanding. I will keep you updated especially when we will need to shut down the site for a few hours to finalize the upgrade.
This was just another slow summer week with not much happening except an escalating mid-east crisis, a catastrophic downed Malaysian airliner, Janet Yellen’s testimony before the Senate Banking Committee and a mixed, but mostly favorable, series of economic reports:
- The Federal Reserve Beige Book described an economy with “moderate to modest expansion”
- The Conference Board’s index of leading economic indicators rose by 0.3% in June, the 10th increase in 11 months
- Initil jobless claims for the week ending July 12th came in @ 302,000 below the 310,000 expected
- Retail sales increased by 0.2% in June but still left sales near its lowest levels since January but up 4.3% year-to-year
- Industrial production was up by 0.2% in June, the 4th increase in the past 5 months
- Construction of new homes fell by 9.3% in June, the weakest showing since September, 2013
- Permits for single-family homes increased for the 2nd month in a row and up 7.5% from a year ago
- Business inventories rose by 0.5% in May
- The Producer Price Index rose by 0.4% in June as the Fed watches for any hint of inflation reaching its 2% target to consider raising short-term interest rates
For the week, the S&P 500 rose by 0.5% for a year-to-date return of 8%, including dividends.
IBD: Uptrend under pressure
BCI: Moderately bullish but cutting my bullish trading stance slightly selling out-of-the-moeny striles 2-to-1. My concerns are relating to the 2 major global conflicts and mixed signals from the housing industry.
My best to all,