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Analyzing a Rolling Down Trade During an Extreme Short-Term Market Decline

Exit strategy opportunities must be taken advantage of with our covered call writing and put-selling trades. When there is a significant overall market decline in the short-term, there will be losses. Our job, as option-sellers, is to mitigate those losses using our position management skill. On October 20, 2018, Alvin shared with me a series of trades he executed with World Wrestling Entertainment, Inc. (NYSE: WWE) for the October 2018 contracts. During that contract month (specifically from October 9th through the 19th), the S&P 500 declined well over 100 points. This article will analyze Alvin’s trades.

 

Alvin’s trades with WWE

  • 9/28/2018: Buy WWE at $96.73
  • 9/28/2018: Sell $100.00 call option for $1.74
  • 10/4/2018: Buy-to-close the $100.00 call at $0.35 (20% guideline)
  • 10/12/2018: Sell the $85.00 call at $2.50 (rolling down)
  • 10/19/2018: Stock price closed at $82.03 and the $85.00 call option expires worthless

 

S&P 500 decline from 9/19/2018 – 9/19/2018

 

exit strategies for covered call writing

Market Decline During the October 2018 Contracts

 

Analysis of actions taken

Viewing this chart from a generic perspective, an educated option-seller (specifically a covered call writer in this case) would immediately think of closing the short call and then analyzing for next-step action. On October 4th, prior to the extreme market decline, Alvin closed the short call using the 20% guideline…good job Alvin. October 4th fell during the 2nd week of a 4-week contract and no immediate action was taken creating an opportunity to “hit a double” by re-selling the same option should share price accelerate. This, too, represented a reasonable position management tactic.

The 3rd week of the October 2018 contracts occurred from October 8th through the 12th. At this point, time value erosion (Theta) was accelerating and opportunities to mitigate were declining. On October 9th, the market began plummeting at a greater rate due to geopolitical forces in a rising interest rate environment (trade war with China, issues with Saudi Arabia and interest rate hikes). Options were re-sold on October 12th, the end of the 3rd week of the contract. By rolling down from the $100.00 strike to the $85.00 strike, Alvin captured an additional $215.00 credit per contract ($250.00 – $35.00). This also “locked-in” a substantial loss on the share side but desperate times call for desperate measures.

 

Possible enhancements to trade management

October 8th -12th represented the 3rd week of a 4-week contract. The time value of our options were rapidly eroding due to Theta. It is possible we could have rolled down 2 times during that week as share price plummeted $9.00 per share. Selling the shares may have also been a consideration but overall market performance was most likely the main factor in the price decline rather than a specific corporate issue. Losing $1081 is certainly no reason to break out the champagne, but by selling and managing our option positions, the unrealized loss was mitigated by $389.00 by selling and managing options.

 

Graphic representation of Alvin’s trades and potential trade enhancements

 

covered call writing exit strategies

Rolling Down with WWE

 

Discussion

Stock markets move up and down in the short-term. As educated option-sellers, we must position ourselves to maximize returns and mitigate losses. This will involve having structured rules and guidelines (like the  20%/10% guidelines), understanding option forces (like the impact of Theta) and acting in a timely manner. My analysis of these trades is that Alvin did an outstanding job of mitigating the short-term market decline impact on the share price decline and may have been able to enhance the results by rolling down earlier in the third week and perhaps creating the opportunity to roll down a second time during that 3rd week of the October contracts.

 

***My thanks to Alvin for sharing his trades with our BCI community and congratulations on a job well done.

 

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:

Alan,

I have read your encyclopedia for covered calls a few times and I’m a premium member. I am 31 years old and currently reside in Suffolk County, NY. The info you have taught me has made me confident to handle my own investments going forward. It is going very well so far. Thank you for sharing. Believe it or not- it has changed my life greatly for the better.

Patrick D.

 

Upcoming events

-May 8th 

Alan will be hosting a free webinar for the Options Industry Council (OIC) on generating income from selling options. Click here to register for free.

-May 13th

All Stars of Options

Bally’s Hotel, Las Vegas

10 AM – 10:45 AM

How to Select the Best Options in Bull and Bear Markets

Free event

-May 14th

Las Vegas Money Show

Bally’s/ Paris Hotel

12:15 – 3:15

Master class encompassing covered call writing, put-selling and the stock repair strategy

This is a paid event hosted by The Money Show

***Alan will also be doing book-signing event at The Las Vegas Money Show

 

***Market tone data is now located on page 1 of our premium member stock reports.

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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 “Analyzing a Rolling Down Trade During an Extreme Short-Term Market Decline”

  1. April 13, 2019 11:24 am #

    Alan,

    After ER is released how long do you wait to enter new trade?

    Sunny

    • April 14, 2019 7:34 am #

      Sunny,

      If a report comes in as market consensus anticipates and/or comes close enough such that there is no post-report price volatility, a new covered call or put-selling trade can be executed that same day or the next day if the report was published after market close.

      If, on the other hand, the report results in a substantial move in price (either up or down) we wait for that price to settle and then write the call or sell the put assuming the stock still meets our system criteria. This latter scenario may take an additional day or two.

      Alan

  2. April 13, 2019 9:20 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 04/12/19.

    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

    Since we are in Earnings Season, be sure to read Alan’s article, “Constructing Your Covered Call Portfolio During Earnings Season”. You can access it at:

    https://www.thebluecollarinvestor.com/constructing-your-covered-call-portfolio-during-earnings-season/

    Best,

    Barry and The Blue Collar Investor Team

  3. April 14, 2019 2:56 am #

    A frequent comment in videos is to avoid earnings dates in covered call writing strategy. Just curious if this suggests that we should favor being entirely out of an underlying stock position in advance of earnings date … or simply to avoid covered call writing for dates that span over earnings dates?

    Thank you.

    Vincent

    • April 14, 2019 7:43 am #

      Vincent,

      If we own a stock that we have confidence in for the long-term, we can hold that stock through the report and then write the call after the report passes. If the stock has Weekly options, we can use those and avoid the call the week of the report. This is one of the principles of the BCI Portfolio Overwriting strategy where ex-dividend dates are also avoided.

      That said, in a traditional covered call writing or put-selling portfolio, we avoid the risk of disappointing earnings reports and so all or almost all of the stocks reporting prior to the contract expiration are not in our portfolios.

      Bottom line: Never sell an option if the stock is about to report. It is okay to own the stock through the report if we are willing to take on the risk of a disappointing report or if the stock lies in a long-term buy-and-hold portfolio with potential tax consequences if an option is exercised.

      Alan

  4. April 14, 2019 4:06 am #

    Dear Alan,

    Recently saw your PMCC webinar. As always you provided very useful information! I like your wonderful work. Thank you very much.

    Can I ask you some questions? I couldn’t find this information in your webinar.

    1.What if our Shorted leg of the PMCC option is assigned to us, do we need to have the capital in our broker’s account to BUY all those shares and then SELL them to the holder of our sold Call Option?

    2. And If I am assigned the sold Call,will my broker’s trading platform ( I am using IB Brokers) automatically BUY to close our Long Call Option and then sell it to the holder of our Short Call leg those shares? OR I have to do it manually by myself?

    Do you have any more webinars/information for Poor man’s cov. calls?

    Thanks a lot!! And please carry on your good work.

    Andrey

  5. April 14, 2019 6:04 pm #

    Alan,

    the “short term ” market decline that started early in October, and lasted throuh the end of January, looked to me more like a stiff correction.

    All my 11 positions were hit badly and simultaneousely, which made it very difficult to apply the exit strategies.

    I did gradually apply the 20/10 rule, and thereafter rolled down once or twice to mitigate losses, but at the end it was very painful when I finally had to pull the plugs.

    My 12 months results were eventually positive, but I did give back aprox. 70% of my hard earned gains.

    To be fair, some of my worst losses were related to my poor timing in leaving some tickers go through ERs.
    The problem was caused by these reports beeing issued in the mornings, when I thought they would come after the bell.
    Therefore, I recommend to all members to watch very carefully the confirmed time of release, as well as the date.

    I believe that I learned some additional skills, and lowered my loss tollerance substantially since this October debacle.

    Btw I am back to fully invested since February.

    Roni

    • April 15, 2019 3:36 pm #

      Roni,

      The more we encounter these extreme market conditions, the less it impacts us emotionally. They still hurt but we are less likely to make improper emotional decisions.

      Earnings reports are important. The dates in red bold in our reports have been confirmed by the corporation.

      earningswhispers.com will also give the time of the release. This site is the most accurate we have come across for earnings data but it is not 100% perfect.

      Alan

      • April 16, 2019 5:36 pm #

        Thanks Alan,

        I always look at Earnings Whispers before placing a trade, but I got careless about the time of release after executing the 20/10 guideline, and several rolling down trades during those hectic days.
        I will make sure that it never happens to me again.

        Roni

  6. April 15, 2019 3:23 pm #

    Alan,

    First of all, I want to thank you for your wonderful, simple and clear Videos on Cash Covered Calls and Cash Secured Puts in the You Tube. Though I have been an investor for 2 decades, I was a novice in these two subjects. Your slow paced clearly explained videos were God Sent for me to understand fairly well the mechanics. Though I need more practice and understanding of the Exit Strategies. Thank You sincerely for the Videos.

    Just a clarification. How rigid are you in terms of 20/10 for the Roll over and Roll over and Up? I have a cash covered put on NVDA which I sold for a strike price of 155 Jan 2020 and collected a premium of $2513.00 for 2 contracts. Stock price on 3/29 was 177.25. Now that the stock price is significantly higher, I was thinking of rolling it over by buying to close at a debit of 1900 and sell to open a 175 put at a credit of 2300 dollars. Total premium of 613 (2513-1900) + 3800 = 4413. This is against the rule of 20/10 exit strategy. But I can earn more profit as stock keeps moving up. Need some advise, if I am missing something. Appreciate a counsel on this. Thank You.

    Haltore

    • April 16, 2019 6:30 am #

      Haltore,

      So far your trade has been a success based on its initial structuring. If the trade was executed within the last month, the 9-month maximum return is 8.4%. That result will be realized as long as NVDA does not move below $155.00 by contract expiration. As of this morning, NVDA is trading at $184.70, so we’re looking good.

      The cost-to-close the $155.00 put as of pre-market this morning is $10.65 which means we are giving back 88% of our original initial time value profit. Let’s say that this maneuver will result in an additional profit of 2% (based on your stats). On the surface that appears worthwhile. But in exchange for the 2%, we are raising the breakeven from $155.00 (less put premiums) to $175.00 or higher (less put premiums). This will then increase our risk.

      On pages 141 – 143 of my book, “Selling Cash-Secured Puts”, I discuss the 20%/10% guidelines for put-selling. It is a combination of the 20%/10% guidelines and mid-contract unwind exit strategy we use for covered call writing. When share price moves up and put value moves down to 20%/10% of the original premium generated, we close the short put and use the freed up cash to enter a new put position with a different underlying thereby avoiding profit-taking on stocks that have dramatically appreciated in price.

      Another way to enhance returns is to consider trades of a shorter duration. The 9-month 1/2020 $175.00 put generates $17.90 while the 1-month 5/2019 $175.00 put generates $5.20. Monthlys will out-perform longer-term trades on a consistent basis.

      Alan

      • April 16, 2019 6:45 pm #

        Alan,

        Truly appreciate your prompt response. I will keep your point of view for future and become a better Option trader. You bring up a good point.

        Thanks once again.

        Haltore

  7. April 16, 2019 5:03 pm #

    Premium Members: 2 new reports now available:

    This week’s 8-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site and is available in the “ETF Reports” section. Look for the report dated 4-16-2019.

    Also, the Blue Chip report of eligible Dow 30 stocks for the May contracts has been added to the member site on the right side of the page.

    For your convenience, here is the link to login to the premium site:

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

    Alan and the BCI team

  8. April 17, 2019 5:54 am #

    AAPL made it back on the Blue Chip list.

  9. April 17, 2019 6:31 am #

    I’m a little confused about the S&p 500 etf. Is it really going for 290.00 a share? That would be quite an investment to use it as a covered call?

    MT

    • April 17, 2019 6:51 am #

      MT,

      Yes, SPY is trading near 290. A 1-month near-the-money call option will generate about a 1% initial time-value return. We must first define our initial time-value return goals before determining which underlying securities are appropriate for our portfolios.

      Alan

    • April 17, 2019 7:44 pm #

      Hi MT,

      You are right about SPY: it’s pricey. And if you buy 100 shares at today’s close that is a $28,945 outlay at an arguably extended point in the market but with still favorable seasonality. The 1% OTM overwrite strike is at $291 for May so that’s only $1.55 breathing room plus the $2.80 premium for $4.35 which is a small gain in a month if bullish SPY. But respectable regardless.

      In low VIX/IV/Options Premium times like this it is easy to ask “why bother?” with sold calls on the index ETF’s. But you can still find good prospects on individual stocks and even some of the much lower sticker price SPDR XL Sector component ETF’s.

      My only suggestion is please stay true to your monthly cash flow targets, accept lower in times like this and don’t go chasing high premiums on that basis alone – I learned the hard way there is a reason for those: it is called “risk” :)! – Jay

      • April 17, 2019 8:06 pm #

        Hi Jay,

        Hope all is well with you.

        I know little to nothing about the VIX. I certainly have never traded it.

        It appears to me that a peak in the VIX signals a low, sometimes short term, in the market and an outsize low in the VIX signals a top, sometimes short term, in the market.

        In your opinion, is this the case?

        Hoyt

        • April 17, 2019 8:11 pm #

          Jay,

          Probably should have used “a low or pause” or a top or pause ” instead of just low and top.

          Sorry,
          Hoyt

          • April 17, 2019 10:04 pm
            #

            Well, Hoyt,

            I must admit I am a grizzled veteran of trading both straight VIX options and some of the futures products like SVXY, VXX and UVXY. You may regret getting me started :)? But all this really is for a hobbyist who has put some time into studying it. I don’t recommend anyone trade VIX casually on little homework.

            I would say that, as always, your observations are correct: “normally” the VIX and SPY are inverse since VIX measures S&P put interest which get’s higher as SPY declines and trails off when SPY is in good shape.

            Yet there is an old saying in volatility trading that “The VIX can stay low longer than you can stay solvent.” The suggestion there is if you see a low VIX (below mean of ~16) it can be tempting to get bearish on SPY and long VIX expecting a reversal. But you can lose a lot of money waiting on that in the long VIX futures products like VXX and UVXY which decay over time because of how they are structured.

            I have had more success viewing VIX as a mean reverting instrument shorting it after spikes above 25 – 30. It typically hits spikes fast on big market drops/Black Swan news events then starts to reverse quickly thereafter. So I find the spikes are easier to “play” than longer quiet periods.

            Early last year the the “short volatility” trade got over played as a holding since VIX had been stable a long time. Then when VIX spiked a lot of people got caught long in the ETN’s and ETF’s that were shorting the “usual” VIX futures monthly curve. Some closed and people lost 100%. Everything works until it doesn’t!

            In the day trading portion of my hobby I watch for VIX divergences from SPY. If the VIX and SPY are both up on the same day I buy puts assuming – for better or worse – the options traders are likely right bracing for a drop in SPY. Same if VIX is going down on a day when SPY is also going down. I’ll buy a few calls betting on an uptick. It’s been a decent trade signal.

            Sorry for this concept dump after your simple question! But you know us die hard hobbyists: this stuff is in our blood 🙂 – Jay

          • April 18, 2019 7:48 am
            #

            Hi Jay and Hoyt;

            Question for you Jay:

            “In the day trading portion of my hobby I watch for VIX divergences from SPY. If the VIX and SPY are both up on the same day I buy puts assuming – for better or worse – the options traders are likely right bracing for a drop in SPY. Same if VIX is going down on a day when SPY is also going down. I’ll buy a few calls betting on an uptick. It’s been a decent trade signal.”

            What options are you trading when you look for these divergences?

            Best;

            Terry

          • April 18, 2019 10:29 am
            #

            Hi Terry,

            Yeah, sorry, I was not real clear on that. In day trading I like either SPY or SPX. SPY is one tenth SPX so you can take smaller positions or budget more contracts but SPX cash settles so you never have to worry about being “assigned” anything. Plus SPX is the full value of the index and large moves tend to be more pronounced dollar for dollar in intrinsic value – for good or bad. They are both tracking the S&P and they both have multiple expirations each week, typically M/W/F. I trade on those days using that day’s expiration. I can find something else to do on T/Th :). – Jay

          • April 18, 2019 1:53 pm
            #

            Hey Terry,

            Quick follow up: this morning I saw another VIX divergence where it was going down faster than SPY was going down. So I bought some SPY calls for today slightly ITM when SPY was negative betting on a possible reversal. As luck would have it I closed that trade for a triple in a couple hours when SPY went green.

            Now, as a community we are conservative investors seeking to beat the S&P using quality stocks/ETF’s and proven option selling strategies. I am aligned with that. So I do not want this or other comments to come across as either debate or challenge to our primary way of making money!

            I am simply a retired guy who is a market junkie. I have studied it enough to take VERY TINY risks on things I would never recommend to others like trading SPY options that expire today.

            Just wanted to make that clear so Alan and Barry don’t give me the boot :)!

            It’s great to have an educated forum like this where we can tee up anything having to do with investing and options! – Jay

          • April 18, 2019 3:31 pm
            #

            Jay,

            Your explanation of the various nuances of VIX vs SPY relationships and TREND INITIATIONS with their potential for option based profits on extremely short times frames was the most succinct one I have ever read or heard.

            I agree that unless one really educates oneself one should not trade the VIX or its derivatives. Some people who thought they were very smart had their clocks cleaned early last year.I am one of those who can live the rest of my life without taking part in that aspect of the market.:)

            Your old saying reminds me of the similar old saying, “The market can remain irrational longer than you can remain solvent”.

            I agree, too, that this blog should be educational about the entire market even if most of us may never enter some areas of it as traders. I am a firm believer that you never learn less.

            What we learn from each other may not lead us to change what we trade but may help us to make better trades in that which we trade.

            Thanks for all the information,

            Hoyt

          • April 18, 2019 4:11 pm
            #

            Thanks Hoyt,

            Your kind words are much appreciated!

            This is a great community I am proud to be a part of for many years. It is wonderful to see it grow with new friends joining us all the time! – Jay

  10. April 18, 2019 2:27 am #

    Alan,

    I start reading your books and I am learning a lot. Great job Alan!!

    I have few questions for now:) :

    1)When you initially look for a return of 2 % a month for example. What happen if you end up owning the stock/ETF as far as future return. Do you calculate the return each month based on the initial cost of the stock/etf? Or and the cost after deducting the premiums already received?

    2) I am little confused on when you sell the stock/ETFs if they go down. Do you base it on technical ( like below a moving average) or a % of decrease? If you use the %, are you using the decrease from the initial cost or the cost after deducting the premiums in case you have some already.

    Thanks in advance!

    Kossila

    • April 18, 2019 2:35 pm #

      Kossila,

      When entering a covered call trade the cost-basis of the stock is the current market value so we can compare “apples-to-apples” if comparing to another investment type. If we rolled a previous option, the cost-basis is the lower of the original strike and current market value, usually the strike.

      When share price declines, we always employ the 20%/10% guidelines for the short call and consider selling the stock if substantially under-performing the overall market. When using a percentage decline from original price when trade was entered, 8% – 10% is reasonable.

      Thanks for your generous comments about my books.

      Alan

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