beginners corner

Adjusting Our Portfolio Mix to Achieve Diversification and Cash Allocation

To decrease portfolio risk for our covered call writing and put-selling portfolios we must be well diversified and allocate a similar amount of cash per position. The allotment of cash per-position will rarely be precise but it is a goal we must incorporate into our methodology. In this article, I will describe the process for covered call writing using the Premium Blue Chip Report (top-performing Dow 30 stocks) for the September 2020 contracts using a $250,00.00 cash balance. The process can be adjusted up or down depending on the cash available.

 

Blue Chip Report for September 2020 Contracts

 

Blue Chip Report for September 2020 Contracts

 

Structuring our strategy requirements for a $250,000.00 portfolio

  • Diversify with 7 elite-performing Dow 30 stocks
  • Allocate $36k per position ($250k/7)
  • Divide the price-per-share into $36k and round to the nearest 100
  • Are adjustments needed?
  • Must leave a 2% – 4% case reserve for potential exit strategy opportunities

 

Portfolio initial setup based on initial strategy guidelines

 

Covered Call Writing Portfolio Setup

Following the initial guidelines, the cost is $15,724.00 greater than the cash available plus there is no reserve for exit strategy. We need to make an adjustment of about $20,000.00. In this case, I decided to reduce my potential CRM holding from 200 shares to 100 shares.

 

Portfolio final setup after the adjustment

 

Covered Call Writing Final Portfolio Spreadsheet

 

We are now diversified with 7 different Dow 30 top-performers and have a reasonable, although not perfect, cash allocation per-position. There is also a cash reserve of $5956.00 for potential exit strategy executions.

 

Next steps

Once we have our portfolio selections, we turn to the option-chains to select strikes that meet our system criteria and immediately enter our 20%/10% guidelines.

 

Discussion

Portfolio risk will be mitigated by diversifying the securities in our portfolios and allocating a like amount of cash per-position. We must also factor in the need for a cash balance to execute potential exit strategy opportunities.

 

Your generous testimonials

Over the years, the BCI community has been incredibly gracious by sending our BCI team email testimonials sharing stories as to what our educational content has meant to their families. Moving forward, we have decided to share some of these testimonials in our blog articles. We will never use a last name unless given permission:

Hi Alan,

Thanks for providing a great service to individual investors, with Blue Collar membership. I am making more profits with your taught methods than I ever made previously.

Raj

 

Upcoming events

1. Money Show Virtual Event: Free webinar

March 17. 2021

12:10 PM – 12:40 PM

Creating an Ultra-Low-Risk Put-Selling Portfolio While Still Generating Significant Annualized Returns

Details and register here

 

2. Market Madness Summit: Free webinar

March 23rd

12 PM ET

Using Both Covered Call Writing and Put-Selling to Generate

 Monthly Cash Flow and Buy Stocks at a Discount

The PCP (put-call-put) Strategy (wheel strategy)

Details and register here

 

3. AAII Research Triangle NC: Private webinar

April 10,2021 at 10 AM ET

Zoom webinar- details to follow

 

4. Wealth365 Summit: Free webinar

April 19th – 24th

Details to follow

 

Alan speaking at a Money Show event

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Market tone data is now located on page 1 of our premium member stock reports and page 1 of our mid-week ETF reports.

****************************************************************************************************************

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.

43 Responses to “Adjusting Our Portfolio Mix to Achieve Diversification and Cash Allocation”

  1. Barry March 13, 2021 1:56 am #

    Hello Alan,

    I need your help to understand a basic concept.
    Let’s say I own a stock that I want to hold indefinitely and sell covered calls on it.

    Lets say I sell slightly out of the money and the stock goes up 10% in first week of a 1 month expiration period.

    I could simply let stock be assigned and keep premium and minimal profit on underlying stock and re-purchase stock at expiration.

    Alternatively I could buy back option early on and re-sell option at much higher strike price with same or following month expiration.

    Please help me think about this.

    Thank You,
    Barry

  2. Joanna March 13, 2021 5:47 am #

    Alan,

    I just cannot bring myself to trust these markets. I don’t want to get in at all time highs…..advice for the skeptics?

    Thanks,
    Joanna

    • Alan Ellman March 14, 2021 7:07 am #

      Joanna,

      We should only trade in markets where we are comfortable. What may be appropriate for one investor, may not be for another. Here are some points that should assist:

      1. Markets appreciate, on average 8% – 10% per year so all-time highs are not momentous events.

      2. If appreciating markets are non-starters are declining markets to be embraced?

      3. Mastering the 3-required skills (stock selection, option selection and position management) allows us to structure our trades in almost all market environments. If we have concern about the market tone, we can set-up our trades accordingly.

      4. Our trades involve weekly or monthly obligations which can be adjusted. Each new contract cycle will allow us to structure our portfolios based on current information.

      Alan

      • Joanna March 14, 2021 9:06 am #

        Alan,

        I like the notion of selling cash secured puts, but in my experience anytime I’ve sold puts, I end up being a bag holder. Meaning the price per share of the security ends up being significantly lower than the strike price I sold the put for. Do you have a rule for unwinding a cash secured put trade? Like, at what percentage below the strike price would you unwind before being assigned?

        Joanna

        • Alan Ellman March 15, 2021 6:36 am #

          Joanna,

          The BCI guideline as when to close a cash-secured put trade is when share price moves > 3% below the (originally) out-of-the-money put strike… the “3% guideline” in my books and video courses.

          Alan

  3. Barry B March 13, 2021 10:09 pm #

    Premium Members,

    This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member site and is available for download in the “Reports” section. Look for the report dated 03/12/21.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:

    http://www.youtube.com/user/BlueCollarInvestor

    On the front page of the Weekly Stock Report, we now display the Top 10 ETFs, the Top SPDR Sector Funds, and the 4 single Inverse Index Funds. They are sorted using the 1-month performances from the Wednesday night ETF report and the prices from the weekend close.

    Best,

    Barry and The Blue Collar Investor Team

    [email protected]

  4. Carl March 14, 2021 3:11 am #

    Alan,

    I am holding the ETF’s for the three major asset class stock indexes (IWM, VO, SPY) as well as GLD. I never plan on selling them (ever) and with that, I have been simply writing covered calls for the next upcoming 40-Delta strike price. If assigned, I simply buy back the index ETF again and repeat.

    Obviously, in a strong bull market like we have had, I am missing out on possible gains in exchange for a “sure thing” in income. And, I realize that if the ETF price goes up, I may be re-buying less shares than I had prior but I figure this will be made up for in the future when (someday) the markets have a pullback and I am buying back more shares at lower prices.

    My ultimate goal here is to eventually have enough shares to generate retirement income while bringing in enough income to also continue buying more shares over time as well.

    I would be honored to hear your opinion on my writing and may I ask you if you see any glaring errors in my strategy?

    Thank you so much, Alan!

    Carl

    • Alan Ellman March 14, 2021 7:25 am #

      Carl,

      When we sell covered calls on securities we plan to hold for the long-term, we are using “portfolio overwriting” In these cases, we use only out-of-the-money (OTM) strikes and set target return goals.

      Using 40-Delta strikes means always using slightly OTM strikes. This means that, over time, a high percentage of the positions will expire in-the-money, requiring us to add more money to our positions. We are balancing option premium and creating scenarios where we need to add cash to our portfolios.

      Another approach would be to lower annualized return goal range requirements and go deeper OTM. This would eliminate the 40-Delta requirement and base the strike selection on strategy initial time-value return goal range.

      As an example, let’s say we are seeking to generate 6% over and above the appreciation and dividends we are receiving from these securities. Our monthly goal would be based on 1/2% per month, not a 40-Delta, and allow us to place strikes much higher and decrease the probability of strikes expiring with intrinsic-value.

      Step 1 is to determine strategy goals and understand the pros and cons and then structure our portfolios based on these parameters.

      Alan

  5. Barry March 14, 2021 3:57 am #

    Alan.

    I own a few high volatility stocks like Bidu, irbt, and gdx. The percent premium for these is significantly higher.

    Granted they may end up in the money more frequently. But as I want to hold the underlying stock I will roll out and significantly up near expiration when appropriate. Does this make sense?

    Thanks again,
    Barry.

    • Alan Ellman March 15, 2021 6:43 am #

      Barry,

      This approach can work as long as we are willing to add additional cash to our trades in the form of intrinsic-value when rolling the options.

      Using deeper out-of-the-money call strikes will mitigate these situations. This will result in lower initial time-value returns in exchange for allowing greater share appreciation.

      Strike decisions should be based on our initial time-value return goal range and personal risk-tolerance. These parameters must be established prior to entering all trades.

      Alan

      • Barry March 15, 2021 8:39 am #

        Alan, thank you again. I just want to clarify to ensure that I understand your answer. In my system for certain stocks I know I want to hold long term. I will usually sell calls far out of the money for these. If stock rises unexpectedly high at expiration l will roll out to next month expiration at a significantly higher strike that is again out of the money. I don’t understand what you mean by needing to add additional cash to the trade. Please clarify.

        • Alan Ellman March 17, 2021 6:46 am #

          Barry,

          Let’s use the following scenario:

          Buy XYZ at $80.00

          STO $100.00 call at $3.00

          At expiration, XYX is trading at $120.00

          BTC the $100.00 call at $20.10 ($20.00 intrinsic-value)

          STO the next month $140.00 call at $3.00

          At this point, we have an option credit of $5.90 but needed to add an additional $2000.00 per-contract to roll the option. The good news is that the $2000.00 per-contract is negated by the additional share value (from $100.00 to $120.00) but additional cash did have to be added to the trade.

          Alan

  6. Jim March 14, 2021 1:21 pm #

    Good Morning Alan and Barry;

    My success with the Blue Collar method has been exciting and after several years of using and learning from you, I find my results continuing to increase… To the point I often ask myself “Are you sure this is legal?”

    I find some weakness in my management skills and hope you may enlighten me a bit.

    Every so often after a successful CC expires or I BTC, in the following cycle I find no CC opportunities as good as the first had been, or I’m often unable to write a CC to achieve a ROO of even .5% for the monthly period.

    I always hesitate liquidating these stocks at a loss, and now they become baggage as I wait for a CC opportunity where I can write for a good return, or hopefully set up a CC in hopes of my stock being assigned without much if any loss.

    What procedures should I be incorporating to possibly keep these ‘deadwood’ positions out of my portfolios?

    Thank you for your input on this issue as I expect other members may also seek a solution.

    I appreciate the work you all put into bringing this exciting BCI method to us, and only wish I had learned of the BCI method 10 years earlier!

    Jim

    • Alan Ellman March 15, 2021 6:51 am #

      Jim,

      These strategies are definitely “legal” or I and thousands of our members, are in big trouble. Credit yourself for all your hard work and due-diligence for the success you’ve enjoyed.

      Now, stocks that offer no good covered call opportunities: Sell the stock and move on… period. The price paid in the past should have no influence on what we do now. If we bought a stock at $40.00 and it’s trading today at $35.00 with no opportunities for covered call writing that meet our goals, we sell the stock and find one that works for us. We must realize that we now have a security worth $35.00/share… where is that cash best placed? In “deadwood” or in an elite-performer with option-generating opportunities… rhetorical question.

      I wish you continued success.

      Alan

  7. Denis March 14, 2021 1:28 pm #

    Alan,

    What do you mean by those two following sentences?

    BCI: I accomplished several doubles so far this contract month due to the market gyrations and, of course, preparation.

    Currently all positions have the 10% BTC limit orders in place.

    Note: I ended 2020 with a net ROI of 34 % . You were the initiator of that success.

    Thank you

    Denis

    • Alan Ellman March 15, 2021 6:59 am #

      Denis,

      Congratulations on a stellar investing year in 2020. I know you have been a dedicated investor with BCI for many years and we appreciate all our international members.

      The 2 sentences in our last member report:

      1. The 20% BTC guidelines were reached in several of my positions, closing the original short calls. Since markets then turned around and recovered, I was able to re-sell those same options at a higher price thereby generating (so far) 2 income streams for those trades.

      2. Since we are in the latter half of the March contracts, I changed all 20% BTC limit orders to 10%. If the original option was sold for $2.00, the 20% guideline would guide us to a BTC limit order of $0.40. In the final 2 weeks of a contract, it would be changed to $0.20 or 10%.

      Alan

    • Roni March 15, 2021 2:05 pm #

      Hey Denis,

      those two sentences baffled me too.

      I mean, 4 of my 20% buyback orders were filled, and a few days later I rolled down 2 of them to mitigate the eventual loss, but my timing was not good enough to hit a double when the market turned. I pulled the trigger too early.
      I am still holding the other 2, waiting and hoping for a favorable opportunity.

      As for the second sentence, I am surprised that Alan is leaving the 10% buyback orders in place since we are in the last week of this cycle.
      I have cancelled all my 10% outstanding buyback orders yesterday.

      Roni

      • Alan Ellman March 16, 2021 8:04 am #

        Roni,

        I encourage our members to adjust the rules and guidelines of the BCI methodology to meet personal risk-tolerance and trading styles. My way isn’t the only way.

        We can also carefully monitor our trades during the final week of a monthly contract to ensure we take advantage of all exit strategy opportunities.

        I like the 10% BTC limit order because I receive notification from my broker, if executed, and then I take appropriate next-step action.

        Over the years, I have published numerous articles and created numerous videos regarding exit strategy executions in the final week of a monthly contract. I know you are an astute investor so I am sure you have as well. Here is a link to an extreme example:

        https://www.thebluecollarinvestor.com/hitting-a-double-on-the-last-day-of-a-contract/

        It is critical that we manage all our trades through the entire contract. Whether we partially automate the process using the 20%/10% guidelines or meticulously monitor the trades without the limit orders is an individual choice.

        Alan

        • Roni March 16, 2021 2:52 pm #

          Thank you, Alan,

          with hindsight today I could have easily hit doubles with my 20% buybacks, or at least sell the roll downs at much higher prices.
          I need to learn to be more patient when we are in the early weeks of the cycle. Especially when the whole market is moving in step.

          As for the last cycle week’s 10% buyback orders, I can now see the advantage of leaving these orders active.

          Roni

  8. Bill March 14, 2021 2:31 pm #

    Alan,

    I have a question about the 20%/10% rule. Most of your examples are using out of the money/at the money calls. If we sell in-the-money calls, do we set the 20%/10% on the total premium or just the time value? As an example, I was looking at an in-the-money call of $4.00 that was in the money by $2.70 and had time value of $1.30. Do I initially set the buy back cost at .2 x 4.00 = .80 or .2 x 1.30 = .26?

    Thanks, as always.

    Bill

    • Alan Ellman March 15, 2021 7:10 am #

      Bill,

      Excellent question I haven’t had in a while. The 20%/10% guidelines are based on total premium. For a $4.00 premium, it would be $0.80/$0.40 whether ITM , ATM or OTM.

      Alan

      • Bill March 15, 2021 2:38 pm #

        Alan,

        Thanks for clarifying that.

        Bill

  9. Richard March 14, 2021 9:17 pm #

    Hi Alan,

    I’m fascinated by your blog posts and videos about stock pinning. Is this phenomenon something you use to help select stocks and strikes?

    For example, option volumes point to a stock pin for AAPL of around $125 in two weeks time. Based on AAPL’s current price of $121, we could comfortably buy the stock and write calls for the $125 strike.

    Do you see this as a reliable guide to assist with stock selection and strike selection?

    Thanks,
    Richard

    • Alan Ellman March 15, 2021 2:17 pm #

      Richard,

      “Pinning” is a phenomenon that occurs at expiration. It is useful to understand the process particularly if retaining the shares is critical to our portfolio goals.

      I do not use pinning for stock or strike selection.

      Alan

  10. Dave March 15, 2021 2:21 pm #

    Allen – I purchased 100 shares of Boeing when it was trading at $127 during the covid dip. I have been successfully selling fairly deep out of the money calls all the way up. In February 2021 I sold a March 19, 2021 $240 call for $6.10 when the stock had abruptly risen to @228. Well recently the stock has had a moon shot and is trading just south of $270 so it is deep in the money. A very nice “unrealized” profit, and I’m certainly not complaining, however, this stock is in a personal account so it will become taxable if I let it expire and let the shares be assigned.
    I’m thinking the shares will come back to earth a bit, but of course, they could keep climbing.
    So, choices I see are:
    1)Let it expire this Friday and have the shares assigned and pay my taxes 2)roll out the 240 to a deep in the money contract and maybe the shares will come back to $240 or less and thus canceling or delaying the assignment.
    3)roll out an up but risk the shares falling.
    Maybe there is another option I’m not seeing.
    thanks! Dave (premium member)

    • Alan Ellman March 15, 2021 6:16 pm #

      Dave,

      If the $240.00 strike is still in-the-money on Friday afternoon, the shares will be sold on Saturday at the strike if the short call is not bought back.

      From an investment point of view, we use the “What Now” tab of the BCI Calculators to review rolling-out and rolling-out-and-up stats to determine if those returns meet our strategy goals.

      I cannot comment on your tax situation but from the information presented, you generated a huge return, with or without paying taxes… congratulations.

      Alan

  11. Rick March 15, 2021 2:22 pm #

    Alan,

    I just became a premium member and had a couple of questions. I am a little confused on the sector diversification and should I buy the covered calls with an expiration date of 3/19 or 4/16? I can also wait until next monday. I was planning to stay away from the tech stocks for a little while longer. I have a little over 50k to invest. I was going to buy the following covered calls tomorrow. Please let me know if this is diversified enough.

    Financial
    HTH 200 at 39.37 / 7874

    Leisure
    BC 100 at 103.59 / 10359

    Agriculture
    AGCO 100 at 138.46 / 13846

    Building
    BLDR 200 at 47.74 / 9348

    Media
    SBGI 200 at 38.40 / 7680

    Total 49107

    Thanks,
    Rick

    • Alan Ellman March 16, 2021 7:48 am #

      Rick,

      Welcome to our premium member community.

      Yes, this mix is appropriate from a diversification perspective.

      We can also turn to exchange-traded funds (reports are uploaded to the member site mid-week on a weekly basis) for even greater diversification.

      If we use monthly options, I like to enter my trades on Monday or Tuesday of the new contracts… March 22nd for the April contracts. Use the ETF Report from mid-week this week and the new stock report coming out this coming weekend.

      Alan

  12. Alan Ellman March 16, 2021 5:24 pm #

    Premium members:

    The new Blue Chip (Dow 30) Report for the April 2021 contracts has been uploaded to your member site. Check the “resources/downloads” section on the right side of the site.

    Alan

  13. Robert March 17, 2021 3:50 am #

    Greetings Alan,

    I have a question about Selling Cash Secured Puts: When selling cash secured puts OTM is the premium automatically added to your account, or do you need to wait until Theta kicks in and erodes the Put to realize the full premium of the option. I’m using TOS and I have a cash secured Put on the position (I sold this Put @ 30 Delta) with another 10 DTE for 1.35. The Put is now worth .65 and I can see the dollar value of the Put. If I buy back the Put @ .65, then I would not still collect the 1.35, correct?

    Best Regards,
    Robert

    • Alan Ellman March 18, 2021 6:55 am #

      Robert,

      When we sell a cash-secured put, the premium is instantly transferred to our brokerage cash account. If we sold the put for $135.00/contract and bought it back for $65.00/contract, we would have realized a net profit of $70.00/contract.

      Alan

      • Robert March 18, 2021 8:23 am #

        Thanks Alan,
        Does the process work the same with Covered calls? If I sell a cc one strike above price, for example. $2.50 and price immediately moves up and to the strike without theta kicking in, will I receive the full premium of 2.50?

        Robert

        • Alan Ellman March 18, 2021 12:09 pm #

          Robert,

          Yes, the same holds true. Once we receive the option premium, it’s ours to keep no matter what happens. We may choose to buy back the option and that will impact the net position but the original premium is ours despite the impact of Theta.

          Alan

  14. Roni March 17, 2021 1:17 pm #

    Alan, Barry,

    I have registered in MoneySchow, but I am unable to watch Alan’s lecture ?????

    • Roni March 17, 2021 1:22 pm #

      Correction – MoneyShow

    • Barry B March 17, 2021 3:52 pm #

      Roni,

      The Money Show had technical problems. I wasn’t able to get in either. As a result, I couldn’t provide real-time answers to attendees’ questions.

      Best,

      Barry

  15. Alan Ellman March 17, 2021 5:52 pm #

    Premium members:

    This week’s 4-page report of top-performing ETFs and analysis of the top-performing Select Sector SPDRs has been uploaded to your premium site. One and three-month analysis are included in the report. Weekly option and implied volatility stats are also incorporated.

    The mid-week market tone is located on page 1 of the report.
    For your convenience, here is the link to login to the premium site:

    https://www.thebluecollarinvestor.com/member/login.php

    NOT A PREMIUM MEMBER? Check out this link:

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

    Alan and the BCI team

  16. Joanna March 18, 2021 2:44 am #

    Alan,

    Historically you have always said that the only risk in covered call writing is ownership of the underlying. By this logic, does this mean that selling cash secured puts is less risky than selling cover calls?

    Joanna

    • Alan Ellman March 18, 2021 6:37 am #

      Joanna,

      The risk is on the stock side for both strategies. When we sell cash-secured puts, we have not, as yet, purchased the shares but we do have a contract obligation to purchase shares at the strike price by the expiration date. There could be a loss if the shares are “put” to us after expiration.

      The breakeven price points may differ between covered call writing and selling cash-secured puts depending on the strikes selected.

      Every strategy that seeks to achieve higher than a risk-free return, has inherent risk. These 2 strategies are low-risk with potential significant annualized returns if we master the 3-required skills (stock selection, option selection and position management. This is why they are so attractive to so many retail investors.

      Alan

  17. Randy March 18, 2021 8:37 am #

    Hi Alan!

    I am a subscriber and happy with the weekly reports.

    What are your thoughts on the constant talk about CRASH CRASH CRASH ?

    YouTube, Bloomberg, CNBC, etc all have mentioned that it is coming very soon.

    I am not a believer of all this crystal ball thing but accented talk on crash is at times disconcerting.

    As the Covered call Strategy is based on buying the stock, what is your strategy advice for CCW (buy protective puts all the time) or just be invested less in the market and be more on the cash side or any other way.

    Best regards,
    Roopinder (Randy).

    • Alan Ellman March 19, 2021 6:16 am #

      Randy,

      I know of no one person who can accurately and consistently predict market movement. There are too many factors that influence our markets in this global economy. We can make informed decisions based on sound fundamental, technical and common-sense principles regarding our trades and will be successful much more often than not.

      I do not see what those predicting doom and gloom in this stock market are predicting. In the premium member weekly stock reports, I explain my current portfolio approach as well publish market assessment of IBD and Dr. Wish’s GMI (general market index).

      I am currently fully invested and favoring out-of-the-money strikes 2-to-1 over in-the-money strikes, a bullish approach to option-selling. Members should invest within their own comfort level and personal risk-tolerance.

      In bear markets, I suggest reading our “Emergency Management Report” located in the “resources/downloads” section of the member site. See the screenshot below.

      CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.

      Alan

  18. Alan Ellman March 19, 2021 12:25 pm #

    “Hit a Double” with XLE on the final day of the March contracts. This is an example of how preparation and opportunity can make us money.

    $112.00 for 2 minutes of effort.

    CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.

    Alan

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