Covered call writing trades can be analyzed from many perspectives. Each analysis represents an enlightening experience as we all learn from each other and share ideas and conclusions. We recently received a series of emails from one of our more experienced and savvy premium members regarding several trades he executed a short while ago. I asked Barry Bergman, Director of Research for The Blue Collar Investor Corp. to respond. Barry spent countless hours re-tracing trade executions, evaluating possible alternative maneuvers and potential lessons learned. Although trades can be analyzed in many ways, I felt that posting the email trail (with the member’s permission) can benefit many of our members. For new members some of the content may seem a bit overwhelming so I suggest you print out the article and reference it from time to time. Here now is the trade history for INVN starting with the initial email:
First, the original email and trade history…
SUBSCRIBER EMAIL #1:
This requests your thoughts about a trade I made that didn’t work out well at all. I lost about 20% of the initial investment in two months. Last month you published a really useful summary by Barry about a trade on CMI that didn’t work out. I wondered if maybe someone on your team would do the same for this trade. If you’re willing to do it and if you want to publish it, it would be fine by me.
The trade details and my thinking at the time of each trade are in the attached Word doc.
Thanks in advance.
• I got in on a good entry point with an up trending stock
• I tried for a couple of doubles on pullbacks.
• I rolled up and out on a positive uptrend.
Any thoughts about what I could have done?
Thanks in advance.
BCI RESPONSE EMAIL #1:
Barry’s initial response:
The BCI system tends to be conservative, with preservation of capital a key component of the methodology. Understanding this…let’s take a look at your trade…
Some initial thoughts…
> As Alan continually advises…stock selection is the most critical element of the BCI
> I reviewed the Premium Report from 2/17/12…the report published just prior to your
– INVN failed the screening process that week
– This means that INVN was not an “elite” covered call candidate that week because…
– The price was at the 20 day EMA
– Both the MACD and Slow Stochastics failed
– No StockScouter rating (not a deal-breaker)
– The stock was only trading since 11/16/11…trading for less than 6 months…Alan
likes to see at least 1 year of price history…stocks with less than 1 year of history
because stocks with less than 1 year history could have higher risk and volatility (also not a deal-breaker)
> INVN then failed to pass the screens per the 2/24/12 report
– Price at 20 day EMA
– Failed MACD and Slow Stochastics
– The stock was only trading since 11/16/11…trading for less than 6 months
– No StockScouter rating
> INVN then failed in the 3/2/12 report
> INVN first appears on the 3/9/12 report with mixed technicals
> Your comment “good entry point with an up trending stock”…
– Just prior to your entry, the stock turned over…not a good sign…could mean that the
uptrend was over. At the time you entered the trade, you didn’t have any idea
whether the stock was pulling back or was, in fact, turning over. You needed
confirmation that this was a pull back.
> On 2/27, INVN closed below to 20 day EMA…this could have been a good time to exit
the trade with only a small loss
> It appears (in my opinion…I could be wrong here) that you were trying to day trade the
covered call…trading/adjusting too soon or over trading
> If you held the trade until expiration on 3/16, the trade would have been profitable
I believe that the primary issue with this trade was stock selection. It did not pass the critical selection criteria until almost 4 weeks into the trade. Also, the stock didn’t have any long term track record/price history…trading less than 1 year (not a deal-breaker but a more risky trade). This trade was then compounded by the adjustment process for the trade.
I think that there are four lessons to be learned from this trade:
 Stock selection is the most critical factor to successful covered call trading…follow
the proven BCI methodology
 Patience…if you waited a bit longer, the trade would have ended successfully
 “Paper Trading” and back testing exit strategies before you commit live cash to the
 The initial return appeared to be higher than the typical return the BCI system looks
for, usually 2-4%. In this case it was over 5%. Higher returns are indicative of higher
volatility in the stock.
SUBSCRIBER EMAIL #2 WITH BCI RESPONSE #2 INLINE:
The subscriber then responded to our first pass review of the trade with follow-up questions…
Thanks so much for your response. This is sooooo helpful!!! I really truly appreciate it! I do have a couple of “ah ha’s”, comments, & questions.
1) My big “ah ha” here is that you don’t recommend entering a position from the list that “passed previous weeks & failed current week.” I thought they were there to use, albeit cautiously, until they dropped down to the “stocks removed from running list this week.” I do see it’s in point 4 of the document “running list from the premium report” but I never internalized this point. This is an important misunderstanding on my part but I’m really glad to now understand. It certainly makes my screening process easier, and I hope better.
We keep the “stocks removed from running list this week” on the report for readers who may have entered the position previously rather than just dropping the stock. In many cases the stock comes back and continues on the “Running List.” The stock is only dropped from the “Running List” if it fails the screening process for three consecutive weeks.
2) Your comments that it had only been trading 6 months and had no StockScouter rating raises a suggestion for me. If you think those are reasons to avoid an entry, then my recommendation would be for you to not include stocks that fall into these camps in the list. Because if it’s in the list it makes me think you believe it is a viable candidate for a conservative investor’s consideration.
As Alan points out, not having a “StockScouter” rating is not, in itself, a reason to eliminate a stock…there are a lot of stocks that “StockScouter” doesn’t cover (usually American Depository Receipts or ADRs which are foreign companies trading on US exchanges). My comment here was to indicate that you didn’t have as clear a picture of the stock as you might have. Many great candidates have not had “StockScouter” ratings in the past.
Having less than one year of chart history has been a point that the BCI Team has discussed numerous times. Alan prefers to see a full year of history so the subscriber can see how the stock performs, what happens to the stock after an ER, etc. We ultimately made the decision to include these stocks but add a comment about the less than one year history (located in the key at the top of the “running list”). Since our subscriber base has a very wide range of risk tolerence, we made the decision to include these stocks, but give a warning. That way, the reader could decide whether to include the stock is a potential candidate for them based on their personal risk profile.
3) The points about day trading and patience I understand. I have always managed my covered call positions by writing OTM on stocks I wanted to keep. I think Alan calls it an overwrite strategy. However, I have believed that in order to get Alan’s 2-4% per month, I thought we had to try and hit “doubles” when the opportunity presented itself so I thought buying back the calls on pullbacks was part of the strategy. Both times I did this I did come pretty close to the bottom of the pullback and the one I resold was at a previous resistance level and the stock was higher than my original purchase price so it seemed like a good place to re-sell it. Having said all this, I would be very interested for more clarification about the “hitting doubles” strategy and why what I did was or wasn’t the right way to execute it or seemed more like day-trading. This seems like something important for me to learn more about.
The goal of “hitting a double” is situationally dependent. Per page 259 in Alan’s new book:
“As a rule of thumb, we attempt to hit a double when the market tone and stock technicals are mixed to positive earlier in the contract period (especially during the first week or early in the second).”
What you did made sense. My comment, re: “day trading”, was triggered by the number of trades in the 3/12 to 3/16 time frame. There are times when we have to say that chasing the stock to repair it just doesn’t make sense and exit the trade. There were number of times that you could have exited the trade with either a small loss or a small gain. I’ll try to reconstruct the trade as best I can…I’m not an accountant, so here is my best effort (note the numbers may be slightly off due to the early laddering of strikes)…
2/21 – Opened the trade with a cost basis (C/B) of $17.13
– STO calls…the average premium from the different strikes was $1.70, so
your C/B is now $15.43
3/02 – BTC Mar 17.50 C at $0.36. C/B = $15.79…stock price is $15.26…loss if exit at
3/12 – BTC Mar 15 C at $2.80. C/B = $18.59…stock price is $19.12 (numbers could
be slightly off due to initial laddering of strikes)
NOTE: You could have exited at this time (before the next trade) with a
$0.53 profit (3.1% ROO on initial $17.13 or 2.8% ROO on C/B)
– STO Mar $17.50 C at $0.75. C/B = $17.84
3/16 – BTC Mar $17.50 C at $3.19. C/B = $21.03
– STO Apr 20.00 and Apr 22.50 at avg premium of $1.76. C/B = $19.27
NOTE: Your C/B on 3/12 was $17.84. The stock closed at $20.10 at
expiration. If you didn’t enter the subsequent trades on 3/16 and let
your Mar $17.50 short call be assigned, you could have exited the
trade with a $0.34 loss
4/03 – BTC Apr 22.50 C at $0.20. C/B = $19.47
4/10 – BTC Apr 20.00 C at $0.10. C/B = $19.57
4/18 – Close trade
My numbers are not exact but reasonably close so you can get the sense of the opportunities that were available to make other decisions.
4) Your point about the initial return was too good to be true is thought-provoking. My ITM strike had an ROO of 2.5% and the near-ATM strike’s ROO was 5.3%. What do you think an ATM ROO level is that should raise red flags — anything over 4%?
My error…I looked at the $2.50 option value but didn’t realize the call was the Mar $15 ITM call. The return for the ATM call was, as you indicate, 5.25%. In ‘normal” market conditions, Alan looks for 2-4% return. Since the return was 20% higher, it set off a yellow flag in my mind. Remember, with due diligence, it may have turned out that the higher return was justified. The BCI methodology tends to be conservative by design. The higher initial return is another factor to consider…among a lot of factors. Your decision to ladder the strikes was spot on!
The 5.25% ROO, by itself, didn’t raise a red flag…more of a yellow flag that suggested a closer look at the stock. When you look at a complete picture, the factors were:
– The stock didn’t pass the initial screening process…immediate disqualifier
– The stock had less than one year history…not a disqualifier, but a flag indicating
a closer look and a decision based on your risk tolerance
– A initial ROO > 4%…not a disqualifier, but a flag indicating a closer look…the
higher the return, the higher the risk
5) My last comment I put last because it’s about the entry point. Now knowing that the recommendation would have been to avoid an entry on this stock because it was not in the white boxes makes this a moot point. But I did want to get more insights about your comment about the trend and the MACD rollover. If you draw a diagonal resistance line across the top of the candle bodies on 11/22 & 2/7 and then draw a diagonal support line across the bottom of the candle bodies on 12/30 & 3/6, you get a very well defined up-trending channel. My entry on 2/21 was at a bounce off the 50% line within this channel. Here’s my question. Since stock selection and entries are important, I would think that entries on pullbacks are better than entries near tops. So having the price pullback or a MACD rollover as part of a pullback doesn’t seem like a bad entry to me. In fact it seems like a good entry. Thoughts?
My comment was based on being put in your position on the day you entered the trade, looking at the chart on that day, and making the trade decision. On 2/21, the price chart indicated that the price had rolled over. When you placed the trade, you, most likely, didn’t know that the price was close to the 20 day EMA. Then, if you looked at the MACD and the Stochastics, they were both below their respective trigger lines…reason to disqualify. Now…looking at the up trending channel you defined…in my personal opinion, it was not confirmed by the technicals…volume, MACD, and Stochastics were showing bearish divergence. Bearish divergence is a flag that there could be an impending change in the stock in the direction of the divergence. While bullish/bearish divergence is, not in itself, a part of the BCI methodology…we try to get a sense of impending changes through the use of the technicals. It is the confluence of all of the data that we generate that gives us a clear idea of what the best course of action should be. However, headline risk is always there, and in this case, it impacted the trade.
Your comment about entry based on pull backs is correct, however, you need confirmation that the pull back is temporary vs. a reversal. Looking at the technicals would have helped you make that distinction. As a side note, INVN appeared in the IBD 50 on the Friday prior to your initial trade. Being on the IBD 50 does not necessarily guarantee that the stock will pass the other screens that are part of the BCI screening process.
SUBSCRIBER EMAIL #3:
Barry, two things.
1) Excellent answers. I really appreciate your thought process.
2) Thanks so much for spending the time to answer in such detail. I’m sure you have plenty of other things to do so I really appreciate the fact that you took the time to help me.
I’ve re-read your answers a couple of times already and I will do it again because I really want to learn to get good at this.
BCI RESPONSE EMAIL #3:
… When discussing the trade with Alan, we had one question about the price that you bought back the Mar 15 option on 3/12/12…can you please verify that value?
BCI RESPONSE EMAIL #4:
The reason that I asked you to recheck the value of the BTC Mar 15 on 3/12 is because the option price based on the closing price appeared too low. So, I decided to do a deep dive to see exactly what happened that day using the TOS platform’s “OnDemand” feature to see the trading activity that day. With some help from the support team at TOS, we found out the details of the trade:
– Trading range for the stock that day was $16.75 – $20.10
– Your trade was probably executed sometime between 10:40 and 10:50
– The stock price at the time of your trade was $17.80
So…with hindsight, the price of your trade does, in fact, make complete sense…Stock price @ $17.80, Strike price @ $15, Option price @ $2.80.
SUBSCRIBER EMAIL #4:
Barry, sorry I was slow to get back to you. This was my first opportunity to respond.
First, it’s fine to use this as an example. I think it’s great to have all of us learn from one another.
Second, your detective work was excellent. The 3/12 BTC Mar 15 occurred at 10:34:19 EST. In my trading journal, I record the stock price when I STO the call because I have my journal set up to calculate the ROO. I don’t record the stock price when I BTC since the final return isn’t based on the closing stock price. However, I just went back to the chart and for the minute of 10:34, the stock opened at 17.91, the low was 17.55, and it closed at 17.62. So your assumption of 17.80 is probably very close given it executed 19 seconds into the minute as it was going down.
In an effort to educate our members, the BCI team will periodically publish real-life trades like these. Although it is impossible to analzyze every trade sent to us, we will make every effort to publish those that would be most beneficial to our BCI community. Many thanks to Barry for his outstanding contribution to this week’s blog.
Covered Call Glossary:
We’ve added a covered call glossary to our ever-expanding website. Look for the link on the top bar of our site:
June 12th: I will be the keynote speaker for the New York City Private Investors Group at the ING Direct Cafe:
To sign up (seating is limited):
Time: 6PM to 7:30 PM
Admission is FREE and non-members are welcome.
This week’s economic reports reflect a sluggish, choppy economic recovery with a bit of long-term concern:
- The Conference Board’s index of leading indicators dropped by 0.1% in April while analysts were expecting a 0.1% gain. This was caused by a decline in the number of building permits and a slight rise in unemployment claims
- The Consumer Price Index (CPI) was unchanged in April due to a fall in energy prices
- The core CPI (excludes food and energy) rose by 0.2% as analysts expected
- Minutes from the Federal Open market Committee’s April 24th-25th meeting showed long-term concern from several members. The concern centered around the European debt crisis and potential government gridlock concerning the debt ceiling and expiring tax cuts
- New residential construction grew at the fastest pace since October, 2008 with 717,000 new homes started. Analysts estimates were for a number around 683,000
- Industrial production rose by 1.1% in April exceeding analyst estimates for 0.6%
- Retail sales increased by 0.1% less than the expected rise of 0.2%
For the week, the S&P 500 declined by 4.3% (ouch!) for a year-to-date return of 3.9%, including dividends.
A comparison chart of the S&P 500 and the VIX shows a technical breakdown of overall market parameters:
The S&P 500 (green field) drops below the trading range at thew blue arrow
The VIX (currently @ 25) breaks out above its trading range at the red arrow
In the past 3 months the S&P 500 has dropped by 5% and the VIX has increased by 37.5%
IBD: Market in correction
BCI: Neutral on US economy but concerned about technical breakdown of overall market and concerns expressed by the Fed. Currently selling only in-the-money strikes and using low-beta stocks or ETFs as underlying securities.
Wishing you the best in investing,
Alan ([email protected])
The Weekly Report for 05-18-12 has been uploaded to the Premium Member website and is available for download.
Barry and The BCI Team
It is my pleasure to welcome a new member of the BCI Community, Ethan Patrick Greenberg. Ethan is the new son of David and Jennifer Greenberg. David Greenberg is our project manager here at BCI. He is the person who built our new website.
Congrats to Mom, Dan, and Ethan.
Two questions about this week’s report.
1) The minor one: Should CRM be in the Week 4 column on the left side? I ask because I was wondering if we have two or three stocks this week that passed all the screens?
2) How should we think about having only 2 or 3 stocks pass all the screens? Is the appropriate approach to focus on just these three plus the ETF list and/or is this a big red sign to keep a lot of cash?
 CRM should not be on the left side in Week 4. The left side is for stocks that are either on the current week IBD 50 or on the current week “Other Stocks. CRM has been on the “Running List” for the past few weeks.
3/16/12 – First entry on report under Week 4 (right side) and Running List (left side) White section
3/23/12 – Appears under Week 1 and Running List in White section
3/30/12 – Appears on Running List in Red section
4/06/12 – Appears on Running List in Red section
4/13/12 – Appears on Week 4 and Running List in White section
4/20/12 – Appears on Week 5 and Running List White section
4/27/12 – Appears on Week 1 and Running List Gold section
5/04/12 – Appears on Running List in Red section
5/11/12 – Appears on Running List in Red section
5/18/12 – Appears on Running List in White section
 The answer to this depends on your personal risk tolerance. With a market that is headline driven, ETFs can make sense…again, depending on your risk tolerance. Staying in cash also makes sense. Per Alan’s Market Tone comments above, “Currently selling only in-the-money strikes and using low-beta stocks or ETFs as underlying securities”.
Alan or Barry,
With so few stocks passing BCI screens this week would you say its better to hold off on new positions until things improve?
See my commentary below.
I just returned home from Philadelphia for my second visit with my grandson (1 week birthday!). I took a look at this week’s premium report to find only a few stocks having passed the strict BCI screens. This is a HUGE red flag warning us that we are in a challenging environment and only experienced, sophisticated investors or those with a high risk-tolerance should consider investing at this time. Using low-beta stocks and/or ETFs with in-the-money strikes is a sensible approach for those looking to hold positions for the June contracts.
(Premium members): Another tool I would suggest re-visiting is our “Emergency Management Report” located in the “resources/downloads” section of the premium site. Even if you plan to stay on the sidelines for the June contracts, re-reading this report can serve as a valuable educational tool.
Now many of us (including yours truly) have stocks that have declined in value this past month due to unfavorable market forces and I have received many emails as to how I handle these scenarios. Hopefully, many of you have rolled down or closed positions mitigating some of these losses. As many of our long-term members know I normally stay in the market and use every skill that I have developed over the years to manage these market aberrations. This may or may not be the right approach for you. A few years ago, I published an article explaining how to manage stocks that have “gapped down” in price but remain solid companies. If you plan to write calls against these equities here is the link to that article:
In 2008, the market had a huge decline and it frightened away many retail investors. They took large losses and would have recouped most or all of those losses had they stayed in the market or re-entered in 2009. They bought high and sold low. Most of these investors regret their decision to flee the market although it is certainly understandable. There still remains trillions of investment dollars on the sidelines waiting to bolster our stock market. Although nobody likes to lose money, I believe that these challenging market conditions can be valuable learning experiences. For some it may be that the stock market is not for them. For me and others, it is that we are going to work through the difficult times to benefit from the normal and bull market scenarios.
The BCI team will continue to work hard to provide our members with the best information and support to assist us in making the most appropriate investment decisions for our families.
Alan and the BCI team
Great input from Alan and Barry, thank you.
I am a premium member, watched all your DVD’s, read the encyclopedia – but have only been doing this for 3 months.
With a focus on the comment “many of us (including yours truly) have stocks that have declined in value this past month due to unfavorable market forces” I was wondering if you treat existing positions any different than starting new.
A) if I was using new money, I would sell ITM calls due to market trending down (despite today’s bounce).
B) I have 4 existing positions that were not called out last month. I believe these are good companies, and the price will eventually move up in the trading range (channel). If I sold ITM calls there would be some downside protection if things continue to tank – but it would also lock in the loss if the option is exercized.
My initial reaction was to put a “sell when these stocks get up to a certain point” limit order. I didn’t consider any of these stocks “dead money”. Then it occured to me that an alternative to a “sell limit order” I could just sell and OTM call in that price range and get some premium even if the stock remaiins sideways.
So I did sell some OTM calls, and just felt strange due to current condions suggesting ITM calls. I suppose it’s human emotion wanting to at least break even.
I did read the articles just mentioned, and did roll down on one of my positions mid-month which does help to offset the loss when things are tanking.
Bob H, if you have some stocks that you plan to hold onto long-term, one example could be dividend paying stocks such as PG, JNJ, etc, selling OTM calls on these is almost always a profitable thing to do. It isn’t a big return but it is steady. Barry wrote an article about one approach to this on 4/9/11 called Using Covered Calls to Increase Dividend Yield.
Thanks Steve. I suppose I am “forced” into the thought of holding onto some stocks long-term.
Dividend would be part of the picture – thanks. Another defense against the errosion.
– I just re-read Alan’s article on “managing stocks that have gapped down” for the 2nd time today, and see that he actually answers my question in that article. The charts show a familiar picture of stocks that have sharply dropped in value. And likely the future weeks will show the sideways movement in a lower range than they were before. In that article he mentions selling OTM calls and it makes sense. One is hoping that it will go up from here, and get off the floor.
Alan, I had just left some questions under the ‘support/resistance’ and ‘slow stochastics’ articles as I thought is more appropriate there. It’s a bit late but hope you see it. thanks
The responses have been posted. I hope you find them useful. Much of this information and more will be found in the “Encyclopedia….” when you receive it.
Barry–I am confused by your response to Steve’s question about whether, in this example, CRM should be in the Week 4 column on the left side as well as being in the running list. I thought that CRM should be in the week 4 column because week 4 column contains those stocks that made the running list. If this is not correct, please correct my misunderstanding. Thanks.
The Weekly Columns are for only those stocks that either appeared on the IBD 50 or “Other Stocks” for that specific week. After that, the stock goes on the Running List so we can continue to track it. There will be times where a stock may be on the weekly side multiple times…but the key is that to be on the Weekly List they had to be on either the IBD 50 or Other stocks that week.
This week’s 6-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site.
For your convenience, here is the link to login to the premium site:
Not a premium member? Check out this link:
Alan and the BCI team
1.wanted to say your site is great, and I’m currently reading your latest book- educating myself- hopefully for my family’s future.Thank you for all you hard work- be noted that you are admired from overseas(I’m from Israel)
2.I was wondering if you can show a real covered call trade example- INCLUDING COMMIOSIONS. I went over your recommended brokers- yet it seems as if the smallest amount per trade would be around 15$ (not sure I’m right)- and I don’t think this is so negligible.
Again-Thank you and your team!
Thanks for the generous remarks. We LOVE to hear from our international members. I pay $5.95 per stock trade and $5.95 + $0.75 per contract for options. This is not the lowest price out there! Below is an example of a covered call trade I made with DSW in April showing a 1-month return of 2.8% with commissions deducted from premiums ($765.28/$27,416.15). This screenshot is taken directly from my brokerage account statement. Click on the image to enlarge and use the back arrow to return to this blog.
Thanks Alan for the prompt answer. However- I’m not sure I still follow from your screen capture
as for the commissions part. Can you please elaborate a bit..?
as you can probably see- I’m a bit new to this, and following your advise I’m still paper trading,
yet I really wish to understand the ropes regarding the commissions and how
they effect my performance.
Glad to assist. The stats above relate to the returns WITH commissions factored in. Here are the stats before commissions:
Buy 500 DSW @ $54.82 = $27,410
Sell 5 x $55 calls @ $1.55 = $775
ROO (return on option) = $775/$27,410 = 2.83%, 1-month return
$765.28/$27,416.15 = 2.79%, 1-month return
Both round off to 2.8%
***The fewer contracts sold, the more impact commissions will have. When selling multiple contracts commissions will be a non-event.
Very helpful. Thanks!
I bought Cashing In on Covered Calls and Exit Strategies.
How can I get ESOC?
It’s on the way. Check your emails.
What is ESOC?
ESOC = Ellman System Options Calculator. Also called the Basic Ellman Calculator.
Is ESOC same as the elite calculator 2012, avalable on the premium site?
ESOC was the original name of the Basic Ellman Calculator in my first two books. As a premium member you have access to the Elite version of the Ellman Calculator which has all the features of the basic calulator + 7 additional tabs. You are COMPLETELY covered.