Covered call writers and all investors using stock options strategies have one thing in common: we all want to achieve the highest possible returns within the framework of our own personal risk tolerance. The focus of this site and The Blue Collar Investor is to provide the education and to share ideas that will help achieve these goals. Education is power and that is our starting point but where do we go from there? In this article, I will focus on the thought process that can be used to become an elite covered call writer and how it reminds me of the casino game of blackjack.
Recently, Mark T. wrote to me with a valid question: If I achieve a 2% return on the sale of my option and one of my trades turns against me, I will end up with less than a 2% return…should my goal be higher than 2% to end up with that goal? So the question becomes how can we generate an initial return and protect and manage our positions such that it will coincide with our final returns or at least as close as possible. The answer lies in throwing the odds in our favor in ways that few covered call writers ever think of. Let’s turn to blackjack first just for the fun of it. I am no expert in this card game but when I do play, I have all the charts memorized. That tells me that given my 2 cards and dealers one up card, what the computers say is the best play…take a card, stand pat, split, double down. If we have a 2-card total of 11 and the dealer is sitting with a 6, we double down (double our bet) and take advantage of a situation where we can increase our returns. If we are sitting with a 6 against a dealer’s ace, we take a card hoping to improve a losing situation. Each situation is handled on its own merit as we strive to move the odds in our favor and much like covered call writing, it all starts with education. The major difference between these two strategies is that covered call writers will make money in the long run and most blackjack players will lose money. The main point here is that Blue Collar Investors must take advantage of all aspects of our BCI methodology to throw the odds in our favor and that is what will make us elite covered call writers.
The 3 aspects of the strategy that will give us opportunities to generate the highest possible returns are:
- Stock selection
- Option selection
- Position management
By selecting the best performing underlying securities from fundamental, technical and common sense perspectives, we begin the process of throwing the odds in our favor. Option selection is based on overall market assessment, personal risk tolerance and chart technicals. Let’s look at a real-life example for KORS, a stock on our Premium Stock List at the time I am penning this article. With KORS trading @ $95.56, here is the options chain for March, 2014, a 5-week return:
We will evaluate the in-the-money $92.50 and $95 strikes as well as the out-of-the-money $97.50 and $100 strikes as we feed these stats into the “multiple tab” of the Ellman Calculator (free in the “free resources” link @ the top black bar on this site):
Now it’s time to throw the odds in our favor. In a bull market environment with chart technicals favorable, we are sitting with an 11 against the dealer’s 6. Time for an out-of-the-money strike. These will generate excellent initial returns (2.9% and 2% in yellow field) but also give us the opportunity for additional income streams from share appreciation (2% and 4.6% more in pink field). This is like doubling down in blackjack or taking advantage of a favorable situation to elevate our returns.
In a bear market environment or with chart technicals mixed, we need an insurance policy to protect our capital. We are sitting with a 6 against the dealer’s ace. We throw the odds in our favor by selling an in-the-money strike, both of which return decent initial option profits (2.5% and 3.6% in yellow field) and one (the $92.50 strike in brown field) offers decent protection of that option profit. So what we have accomplished here is to generate some protection against a potential losing trade and to enhance profit potential for winning trades and this will allow us to achieve our goals in normal market conditions.
We are not finished yet because we haven’t started to execute our exit strategy opportunities. Some (“hitting a double”, the “mid-contract unwind”) will allow us to generate a 2nd income stream in the same month with the same cash) and others (like rolling down or closing the entire position) will allow us to mitigate losses. These strategies are discussed in detail with examples in my books and DVD Programs.
Throwing the odds in our favor and taking advantage of opportunities are factors that distinguish Blue Collar Investors from all the others. When we’re sitting with a 16 against the dealer’s ace we do not sit there like a deer in headlights with sweat pouring down our foreheads…we take a card. There may not be a great play all the time but there is always a best play and it’s all about throwing the odds in our favor like nobody’s business (an expression my mother uses).
Next live seminar:
Long Island Stock Traders Investment Group
Monday, March 10th
6:45 PM – 9:30 PM
999 Old Country Rd, Plainview, NY
My seminar in Orange County California has been moved from June 7th to June 14th. Details and link to register to follow
New Fed Chairwoman, Janet Yellen, re-affirmed her commitment to continue the course to slowly decrease the government’s bond-buying program as the economy improves. This week there were only a few economic reports and they were rather unimpressive perhaps due to extreme weather conditions throughout the country:
- The second estimate for Real Gross Domestic Product for the 4th quarter, 2013 is projected to be 2.4% annualized, lower than expected (2.5%). This is well below the 4.1% reading for the 3rd quarter
- This revised data now puts GDP growth @ 1.9% for 2013, less than the 2.8% for 2012 and slightly higher than the 1.8% reading for 2011
- New orders for durable goods (a measure of the number of orders for a broad range of products—from computers and furniture to autos and defense aircraft—with an expected life of at least three years. Durable-goods orders are a leading indicator of industrial production and capital spending. Data fluctuate widely from month to month and are often subject to significant revision) fell by 1.0% in January, less than the 1.7% projected by analysts
- The Conference Board’s Consumer Confidence Index (a gauge of consumers’ attitudes about the present economic situation as well as their expectations regarding future conditions. Consumer confidence tends to have a strong correlation with consumer spending patterns) dropped to 78.1, below the 80.3 expected
- Sales of new single-family homes surprisingly rose by 9.6% in January to an annualized post-recession high of 468,000 units while analysts were anticipating 400,000 units. This was increase of 2.2% year-to-year
- The median price of new single-family homes was 3.4% higher, also year-to-year
For the week, the S&P 500 rose by 1.0%
IBD: Confirmed uptrend
BCI: Cautiously bullish favoring out-of-the-money strikes 3-to-2
My best to all,
Alan ([email protected])