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Analyzing Buy/Write Net Debit Limit Orders

Covered call writing trades can be entered by legging-in (buy stock and then sell option) or as a buy/write trade (one net debit limit order). In the latter order, the option premium is deducted from the stock price and the broker is required to execute the trade and that price or better or the trade will not be executed.

 

Real-life example with M.D.C. Holdings, Inc. (NYSE: MDC)

On 2/13/2020, Patrick sent me information on his first covered call trade using the buy/write combination form. Here is his trade:

  • 2/13/2020: Buy MDC and sell the 3/20/2020 $45.00 call option for a of $43.15
  • 2/13/2020: The order was accepted and executed at the $43.15 price

 

Broker trade form showing the executed trade

MDC Buy/Write Trade Executed at $43.15

The brokerage statement shows that MDC shares were purchased at $44.33 and the $45.00 call was sold for $1.18, resulting in the $43.15 debit.

 

Initial calculations using the Ellman Calculator

MDC: Initial Calculations

The trade generates a 36-day initial time-value return of 2.7% with an additional upside potential of 1.5% if share price moves up to the $45.00 strike by contract expiration. This is a potential 4.2% return, 42.6% annualized.

 

What price should we use as the cost-basis for the stock?

When analyzing the stock portion of the trade, the brokerage statement tells us that share price was executed at $44.33. We use this figure for our management decisions. For tax purposes, our advisor may use a different stat depending on the ultimate outcome of the trade.

 

Discussion

Buy/write trades, also known as net debit limit orders are executed at one price. The brokerage statement will break down the share cost and option premium that resulted in the stated net debit limit order.

 

Investment club program board members

If you would like to schedule a private webinar with Alan and Barry, send an email to:

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Include:

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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,

I want to share with you my recent stock investing experience. I am focused on monthly covered calls with a sprinkle of puts as well. I have invested $80k in my traditional IRA starting in April 2020. I have generated an income of $17,500 in 4 months. With stock appreciation too, I am right now at $112k. Between this and my Roth IRA, I am generating an income of $5k per month.

Thank you so much,

Murali

 

Upcoming event

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Saturday September 19th

9 AM – 12PM PT

 

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Master Class (2-hour)

Creating a Covered Call Writing Portfolio Start to Finish

I am invited speaker for this event. The Money Show charges a fee to attend ($139)

September 16, 2020

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For information click here

 

3: Free webinar for entire BCI community (October)

The feedback from our August 13th webinar was so positive, the BCI team decided to schedule another in the fall. I have written over 50 webinars over the years and will select one or write another based on your feedback regarding the topics you are most interested in. Send your ideas to: [email protected] We will publish the topic, date and time in the near future.

 

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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.

38 Responses to “Analyzing Buy/Write Net Debit Limit Orders”

  1. Steve H September 5, 2020 2:34 am #

    Hi Alan,

    Hope all is well!

    As you know, we are seeing a bit of a correction here. I’ve had 2 positions BTC using the 20% rule. I think I’m going to wait til next week before selling more calls on the shares..

    I’m keeping emotions out of it this time, Just going to stick to our strategies/ adjustments. Is there ever a time where you pull the plug early on a monthly covered call? Just curious.

    I’m down about 3% from earlier in the week. Have a good weekend!

    Thanks,
    Steve H

    • Alan Ellman September 5, 2020 6:07 am #

      Steve,

      The BCI guidelines have 3 circumstances when both legs of a covered call trade are closed mid-contract:

      1. Price accelerates exponentially, leaving the strike deep in-the-money with the time-value component approaching zero. If we can generate at least 1% more than the time-value cost to close, we consider this “mid-contract unwind exit strategy”. This is not applicable to what happened this past week.

      2. The stock is significantly under-performing the S&P 500.

      3. Stock price declines by 7% – 8% from the stock price at the time the trade was initiated. In our new Elite-Plus Calculator, we include a 7% exit strategy column with the understanding that the user can adjust according to user’s comfort level.

      Nice job implementing the 20% guideline.

      Alan

      • Steve H September 5, 2020 9:44 am #

        Good morning Alan,

        Thanks very much Alan! That’s exactly what I was looking for and luckily things improved yesterday a fair bit.

        Happy Labor Day Weekend!

        Steve H

  2. Roni September 5, 2020 10:51 am #

    Alan,

    I have been using the buy/write alternative since the broker’s commissions were quite expensive and they charged a single commission when you placed a buy/write order.

    Another thing to consider is the number of contracts because the broker charges a commission for each contract, and when the stock price is very low, we generally must enter multiple contracts to get a substantial value.

    Today, I use the limit debit only when the bid/ask spread is significant, otherwise, the market order is easier and sometimes advantageous.

    My question is :
    Is there a bargaining advantage for doing limit orders separately instead of the buy/write mode?

    Roni

    • Alan Ellman September 6, 2020 7:48 am #

      Roni,

      Yes, when the spread is large enough, say $0.15 or more. We have a slight advantage by leveraging the “Show or Fill Rule” by setting a limit order on the option side, requiring the market-maker to either execute the transaction or publish the narrower spread. Frequently, market-makers will execute our “negotiated” limit orders in order to retain the larger published spreads which is advantageous to them.

      Buy/writes can be favored when the option spreads are narrow as we place limit orders on the entire trade, not specifically on the option side.

      If leveraging the “Show or Fill Rule” and our broker has an “all or none (AON) box”, do not check it or the “negotiation” will not work.

      Alan

      • roni September 6, 2020 2:49 pm #

        Thank you Alan,

        this is very helpful.

        Roni

  3. Ken September 5, 2020 4:00 pm #

    Hi everyone,

    I place 20% BTC on the calls and stop loss on 93% of the stock purchase price (equivalent to exiting at 7% loss). Last Thursday and Friday, more than half of my positions hit the stop loss, while most of the calls did not hit the 20% BTC, presumably because the implied volatility has increased across the board. My broker allows this as I have a margin account. Realizing that these calls have become naked, I needed to make some decisions. These are what I did, but I’d like to know what you would have done in these situations:

    1.) For stocks that have continued to fall after the stop loss, I observed them for a few hours, and when they seemed to stop falling, I repurchased them. Then I placed lower stop loss since I have unrealized gain.
    Sample: originally purchased at $100, stop loss set and triggered at $93.
    Continued to fall and repurchased at $90 when it stabilized a bit.
    Set the stop loss at $87 (since there was $3 gain).
    Is this correct, or would you just buy back the short call?
    This happened on MITK, TAN, GNRC

    2.) For stocks that rebounded higher after the stop loss, I just bought back the short call early and realized a small profit on the call, while taking a bigger loss on the stock. I was thinking that if I repurchase the stock at a higher price or let it run above the strike, the losses might be greater.
    This happened on EBAY, AMD, PYPL, SAIL, CDNS, and LOW

    In both cases, there were significant net losses incurred. How could I have done better in these cases? If I didn’t use the stop losses, they could have gone down much further like they did in March.

    Now that I have cash in the account from the exited positions, do you recommend investing them again for CCW on Tuesday (using the new screening list), staying on the sidelines, or selling CSP?

    I feel sad that the 7-9% losses are gonna take 2-3 months of CCW to break even, so I want to make sure I learn from the mistakes.

    Thanks in advance!
    Ken

    • Marsha September 6, 2020 8:00 am #

      Hi Ken,

      I don’t think I would be brave enough to be in a naked option position. None of my 20% BTC orders were hit at the end of the week because the prices moved way up before the downturn. If any did get filled, I would have waited to hit a double and may have with the stocks that moved up in price. For the stocks that moved down, I probably would have sold or waited until Tuesday to either roll-down or sell the stock. Good luck to you.

      Marsha

      • Ken September 6, 2020 4:19 pm #

        Hi Marsha and Roni,

        Thank you for your responses.

        Does it mean I shouldn’t use stop losses? The naked positions happened because the 7% stop losses were triggered but the 20% BTC on the calls did not hit due to higher IV.

        Alan, what’s your take on this?

        • Jay September 6, 2020 5:29 pm #

          Hey Ken,

          Thanks for starting a great discussion! My two cents is I separate the option and stock parts.

          When we buy back a covered call for 10 or 20% of what we received we are taking a profit! But when a 7-10% stock stop loss gets hit we are locking in a loss which is often transitory and not needed unless that stock or sector is about the only thing going down or if it is going down dramatically out of step with it’s peers and was just a bad pick at the time versus others?

          My experience is when I used formulaic stop losses and pre-entered them on stocks the tendency was for the machines to “see” those when they accumulate, run them, then take the stocks back up leaving me holding the bag!

          I have found it better to look at the stock and the sector in the context of it’s broader index and go from there. Otherwise I tended to get whipsawed losing more than I would have if I had not pre-entered the tight stop.

          An exception to this is if I know I will be away from the market for a while, will not be watching it and want a stop to be active during that time. – Jay

          • Ken September 6, 2020 6:40 pm
            #

            Thanks for your inputs, Jay. I should probably skip the stop losses next time and analyze if the correction affects all or just the stock. I will try to reenter on Tuesday with the new list, but now I wonder if I should go ITM for more protection, or OTM to try to catch any rebounds

          • Jay September 6, 2020 7:50 pm
            #

            I appreciate your kind and prompt follow up on a long weekend, Ken! Sadly, I suppose there are guys like us who have a hard time taking a break from this stuff :)?

            Since commissions evaporated I have become more of a one to two week trader. I also find it helpful to have a flexible price action dependent plan coming into a new week. If Tuesday is up I am not going to buy anything new, Too hazardous now. I will sell a couple ATM cc’s on things I have not covered yet. If it is another wash out day I will sell a couple csp’s further under the market on things I like in tech.

            I am not of the mind to do capitulation selling of positions here. Trump and his Fed will not let this get that much out of hand before the US election in, as always, only my opinion :)! – Jay

          • Ken September 7, 2020 9:09 am
            #

            Yes, I can’t get my mind off on what happened last week, even during the long weekend. I’m afraid to repeat the same mistakes if I don’t learn from them. I’m not used to seeing more than half of my stocks hitting 7% stop losses before the 20/10% BTC on the calls are triggered. Thanks for your inputs again, Jay!

    • roni September 6, 2020 3:35 pm #

      Ken,

      I agree with Marsha.

      Presently I am 100% invested with monthly CCs expiring 09/18/20, and I had the 20% buyback orders on all of my positions.
      2 out of my 12 buyback orders were filled last Thursday, (GTLS and PANW), and my paper loss on these tickers is around 7%.
      Depending on next week’s market, my plan is to roll down to mitigate the losses, or unwind and look for better soldiers.

      I have already changed all the remaining open orders from 20 to 10%.

      PYPL is one of my positions too, but it is less than 1% under my breakeven.

      Roni

    • Alan Ellman September 7, 2020 7:22 am #

      Ken, Marsha, Jay,

      Thanks for an important discussion and sharing this information.

      Most retail investors (including myself) should not find themselves in naked options positions. Covered call writing is a low-risk option strategy where capital preservation is a core element. There are rare exceptions for sophisticated traders with a high risk-tolerance. Naked option trading also requires a higher level of broker approval which most retail investors will not receive.

      If we conclude that we fall into the majority group, we must close the short call prior to selling the stock. In the BCI methodology, we use the 20%/10% guidelines to assist and partially automate the process. If the threshold is reached, we decide on which is our next step (wait to “hit a double”, roll-down or sell the stock). Some members use a 7% – 10% guidelines as when to sell the stock. Others use a comparison with the price performance of the S&P 500, some use both.

      Keep in mind that we can unwind our position at any time (“convert dead money to cash profits”). We can close both legs of the trade (option first or with a buy/write order) if a stock drops to a specified loss point… but not as an automated broker order.

      As far as entering a trade with 2 weeks remaining until expiration there may be some opportunities. We have many members who use Weekly options routinely… I favor Monthlys but do use Weeklys when they benefit my results (avoiding earnings reports, stock replacement mid-contract). If a covered call position that meets our system criteria returns a 2-week 1% or more initial time-value profit especially for an ITM strike, I will give it consideration.

      Enjoy the holiday and back to work tomorrow.

      Alan

      • Ken September 7, 2020 8:28 am #

        Thank you Alan, I will stop placing the stop losses on the stocks that caused the naked positions. I will reenter on Tuesday with the new list, hopefully avoiding getting whipsawed from the drop last week.

  4. Barry B September 5, 2020 11:58 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 09/04/20.

    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 3 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]

  5. Vinh September 8, 2020 3:23 am #

    Hi Mr. Alan,

    I am a member and watched Selling Cash-Secured Puts lesson 7. In the first half of the contract, if the stock price falls below the strike of the put > 3%, we should exit. How do we set up automatic exit? How to calculate the option price at the stock price goes down > 3% to preset exit? I mean something is similar stop loss.

    Based on the video, it is still ok to keep the option even though the stock price > 3% in the SECOND half of the option contract? Isn’t it?

    Thanks for your help. I like the way you talk in the video (slow and clear)

    Vinh

    • Alan Ellman September 8, 2020 7:51 am #

      Vinh,

      The 3% guideline for selling cash-secured puts applies throughout the entire the contract. You will have to monitor the stock price unless your broker has a notification process if share price dips below the threshold established. If a stock is trading at $51.00 and we sell a $50.00 c-s put, we close if share price drops below $48.50.

      If the stock price is below the strike but less than the 3% threshold at expiration, we decide if we want to take possession of the shares as we might if using the PCP (put-call-put) strategy. If yes, we allow assignment. If no, we close or roll the option.

      Alan

  6. Nathan September 8, 2020 10:40 am #

    Good morning Alan,

    My goal with this email is to more accurately understand rolling down so when an asset does decline in value, I can minimize the money lost. When I do decide to roll down after the 20%/10% guidelines have been met, how should I go about determining what strike price to roll down to?

    Thank you for your time,

    -Nathan

    • Alan Ellman September 8, 2020 4:50 pm #

      Nathan,

      For the 20% guideline, we are in the first half of a contract with potential to enhance gains. We may choose to wait to hit a double, roll-down or sell the shares if share price continues to decline.

      If the 10% threshold is reached, I am more inclined to roll-down and there I look to roll-down to an out-of-the-money strike. This allows for additional time-value premium plus the opportunity for some share recovery. At this point, we are in mitigation mode so any strike that will meet those 2 criteria will suffice. If market volatility is high, I may look to hit a double if more than a week remaining until expiration.

      Alan

      • Nathan September 9, 2020 1:57 am #

        Hi Alan,

        Thanks for taking the time to provide a thorough answer! I really appreciate you helping me better understand the material. Learning cover call writing has me feeling like I am 10 years old again asking a bunch of questions to try to understand the world. Thanks so much for having patience with me!!!!

        My fear is the equity drops in value big time and I want to be prepared to mitigate losses by rolling down appropriately. In your second example above where the 10% threshold was met and you rolled-down to an out-of-the-money strike, If the equity drops again and the 10% threshold is met again and the option is bought back, would I roll down a second time to an out-of-the-money strike, or would that be the appropriate time to roll down to an in-the-money strike? If you would roll down to an in-the money-strike, how far would you roll down?

        Thank you for your help!

        -Nathan

        • Alan Ellman September 9, 2020 6:11 am #

          Nathan,

          Yes, rolling-down a second time is a viable strategy and one that I have implemented routinely in bear markets. I would favor an ITM strike when I plan to remove the stock from my portfolio for the next contract month (upcoming earnings report, for example). I would select a strike that generates a meaningful time-value return (greater than the cost-to-close the previous strike).

          Alan

        • Pavel September 9, 2020 6:31 am #

          Hello Alan,

          First of all, thank you for your website and youtube – all very helpful and informative.

          I am contacting you with a hope that you could comment on the strategy I use:

          1) Pick good weekly optionable stocks (dividend aristocrats, large cap “defensive” companies, ETFs).
          2) Sell cash secured put ATM or ITM with delta ~0.5. Repeat until assignment.
          3) Sell covered call Out of Money or At the Money (with check that the total premiums and stock prices balance for steps 1-3 secures the acceptable annual return). Repeat until assignment.
          4) After assignment go to #1.

          Do you see any vulnerabilities here? How this approach looks against just selling out of money calls?

          Please sorry for disturbance and I hope you could advise on the above.

          Best regards,
          Pavel

          • Alan Ellman September 9, 2020 3:10 pm
            #

            Pavel,

            I refer to this as the PCP Strategy (put-call-put) in my books and DVDs. It is a solid strategy. My preference is to start with OTM puts and, if exercised, write ITM or OTM calls depending on overall market assessment and chart technicals. This way, we don’t lock ourselves into 1 type of strike for all occasions.

            In a bull market environment, I would prefer OTM call strikes.

            Alan

  7. Ibrahim September 8, 2020 1:05 pm #

    Hey Alan

    I have a question. You recommend CORT for this week report (September 4). I’m interested in writing a month out covered call. What happens if it falls out of favor next week or the week after for technical or fundamental reasons? So I try to get out? Or you recommend writing weekly/biweekly covered calls?

    Ibrahim

    • Alan Ellman September 9, 2020 6:17 am #

      Ibrahim,

      Both Weeklys and Monthlys work when the stock offers both. I favor Monthlys and use Weeklys to circumnavigate around earnings reports.

      Once we enter a covered call trade, we immediately place a buy-to-close limit order based on our 20%/10% guidelines and manage from there, not based on the stocks removal from future premium reports.

      Check out the exit strategy sections of my books/DVDs which detail these decisions with real-life examples.

      Alan

  8. Dr. Lonnie September 9, 2020 8:35 am #

    Hello Alan,

    Should be close positions prior to election, i.e., considering it as earnings report incident?

    Dr Lonnie

    • Alan Ellman September 9, 2020 3:14 pm #

      Dr. Lonnie,

      I never tell others what to do but always happy to share what I’m doing. In 2016, I moved to 100% cash prior to the election and moved back in about a week later. At this time, I plan to do the same this year. I will post my intentions in our weekly member reports.

      Alan

  9. Terry September 9, 2020 9:30 am #

    Seasonality chart

    • Roni September 9, 2020 11:23 am #

      Thanks, Terry,

      This chart cheers me up today.

      Roni 🙂

    • Hoyt T September 9, 2020 11:51 am #

      Terry,

      AWESOME!!!!

      Thank you very much! I just printed out the chart and I am trying to find a place to tape it where I will see it every day for the rest of the year.

      I just noticed this is an election year seasonal composite. Can you see if they have a seasonal composite for the year after an election year? 🙂 A seasonal composite for all years? These would be very helpful as a guide. I realize this is the mean. However, it would always be helpful to know how far away from the mean we are at any point in the calendar.

      Does Bloomberg have a site where this can be found?

      Thanks again, Terry.

      Hoyt T

      • Terry September 9, 2020 3:25 pm #

        Hi Hoyt and Roni;

        I was doing some research and came across this chart and liked it so much that I thought that I would share it. Unfortunately this is all I have.

        Best;
        Terry

        • Hoyt T September 9, 2020 5:13 pm #

          Terry and Roni,

          I found this very interesting site. It’s a Composite of the S&P 500 by President from their election day. Many people will be surprised. I have always said I made more money under Bill Clinton’s presidency.

          https://www.macrotrends.net/2614/sp500-performance-by-president-from-election-date

          Facts are facts.

          Hoyt T

          • roni September 10, 2020 4:47 pm
            #

            You are professionals by now.

            I only started in 2010.

            Roni

  10. MarioG September 11, 2020 8:22 am #

    Alan,

    A. ETF Report comments:

    The following ETFs, listed as not having weekly options, should be marked as having Weekly options:
    XLB
    XLC
    XLP

    All the others are listed correctly, which I double checked.

    B. Top SPDR comments
    What is your criteria for listing more than 3 SPDR ETFs in the report?

    *****
    Nice to see all the action in the blog this week. I will put in my 2 cents worth next week. Too late now.

    Mario

    • MarioG September 11, 2020 8:48 am #

      Is the answer that you list more than 3 SPDRs if they are other SPDRs in the Top Performing ETFs list that meet the RS greater than 60 and other requirements?

      Mario

      • Alan Ellman September 11, 2020 8:53 am #

        Mario,

        Yes. I will be changing the header to read “Top-performing Select Sector SPDRs” and those included will have out-performed the S&P 500 in both 1-month and 3-month time-frames.

        Alan

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