One of the key methods to partially automate our covered call writing exit strategy arsenal is to place buy-to-close (BTC), good until cancelled (GTC) limit orders to close our short calls based on our BCI 20%/10% guidelines. We instruct our broker to buy back the short call if the value reaches 20% (in the 1st half of a monthly contract) of its original sale value or 10% in the last 2 weeks of a monthly contract. Option value will decline as share value declines (Delta) and as time passes during that contract (Theta). For example, if we sold a covered call option for $2.00, we’d place a BTC GTC limit order to buy back that option if value decreased to $0.40 in the 1st half of a monthly contract and $0.20 in the last 2 weeks of that contract.
I am frequently asked if those guidelines are based on the time-value component of the premiums only or if intrinsic-value (IV) should be included in the calculations for in-the-money (ITM) strikes. This article will detail a real-life example with XLE which will demonstrate why the 20%/10% guidelines apply to the entire premium of ITM strikes.
Real-life example with Energy Select Sector SPDR Fund (NYSE: XLE – an exchange-traded fund or ETF)
- 11/25/2022: XLE trading at $92.21
- 11/25/2022: The $89.00 ITM strike has a bid-price of $4.95
- The time-value component of the $89.00 strike is $1.74
- Do we base our 20%/10% guidelines on $4.95 or $1.74?
- 11/25/2022: The $95.00 OTM strike has a bid price of $1.77
- The $95.00 strike is all time-value and therefore will be the basis of our 20%/10% guidelines
XLE option-chain on 11/25/2022
XLE Option-Chain for ITM and OTM Strikes
- Brown cells: The $89.00 (ITM) strike has a bid price of $4.95 and a Delta (amount a premium price will change for every $1.00 change in share price) of 0.68
- Yellow cells: The $95.00 (OTM) strike has a bid price of $1.77 and a Delta of 0.38
Initial trade calculations using the BCI Trade Management Calculator
XLE: Initial Covered Call Calculations
- 22-day and annualized returns are practically identical (bottom left of screenshot)
- Yellow cells: Breakeven price points
- Brown cell: The $95.00 OTM strike offers 3.03% of upside potential (share appreciation up to the OTM strike price)
- Purple cell: The $89.00 ITM strike offers 3.48% downside protection of the initial time-value profit
What is breakeven?
This is the price point at which there is no gain or loss. It is the price of the underlying security at the time of the trade minus the entire option premium.
Delta calculations to the 20% guidelines
We take the difference between the original premium and the 20% amount and then divide by the Delta. This will provide an approximation of how much share value must decline to trigger the breach of the 20% guideline. Below is a spreadsheet I created to reflect these calculations for the $89.00 strike using both time-value only and the entire premium as well as calculations for the $95.00 strike.
20%/10% guidelines as they relate to breakeven (IV = intrinsic-value)
20%-10% Guidelines and Breakeven Price Points
- Typically, the 20% guideline will be breached when share price dips slightly below the breakeven price, giving us opportunities to mitigate the small losses or even turn losses into gains
- By using the entire premium (time-value + intrinsic-value) for ITM strikes and not just time-value, we will close the short call at a higher share price
Discussion
The 20%/10% guidelines will assist in automating our exit strategy implementation when share price declines. The 20% guidelines are changed to 10% prior to the final 2 weeks of a monthly contract. When using ITM call strikes, we base our 20%/10% guidelines on the entire option premium.
BCI Community live Zoom webinar May 11th: A streamlined version of covered call writing: Register here.
New Book + 2 New Spreadsheets
Previously shared with premium members and now with the entire BCI community. For those with busy schedules who seek to generate cash flow and beat the market on a consistent basis in a user-friendly and time-efficient manner. A “don’t miss” presentation.
- Thursday May 11th at 8 PM ET
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- Registration form below
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Upcoming events
1.BCI total community
Covered Call Writing: A Streamlined Approach (CEO Strategy introduction)
Thursday May 11,2023
8 PM ET
Zoom login link will be provided to 1st 500 attendees.
Alan Ellman is inviting you to a scheduled Zoom meeting.
Topic: Covered Call Writing: A Streamlined Approach: Live Webinar
Time: May 11, 2023 08:00 PM Eastern Time (US and Canada)
To ensure a spot, fill out the registration form by clicking here.
2. Mad Hedge Investor Summit
June 14th at 11 AM ET – 12 PM ET
Exit Strategy Choices After Exercise of Cash-Secured Puts
When we sell cash-secured puts, we are undertaking the contractual obligation to buy shares at the strike price by the expiration date. Typically, we only sell puts on elite-performers that we would be agreeable to own in our portfolio.
This presentation will analyze 4 potential exit strategy opportunities to consider should the put option be exercised. Information on the following strategies will be highlighted:
- Selling the stock
- Holding the stock in our long-term buy-and-hold portfolio
- Write a covered call (PCP or “wheel” strategy)
- Implement the Stock Repair Strategy
In addition to these strategies, the following topics will also be included in the webinar:
- Option basics for selling cash-secured puts
- Option basics for covered call writing
- Real-life examples
- Calculations using the BCI Trade Management Calculator (TMC)
- Event super discount offer
There will be information offered to all levels of options trades, from beginners to advanced.
Registration link to follow.
3. Your Mid-Year Portfolio Review Virtual Expo
June 27th – 29th, 2023
4. Wealth365 Investor Summit
July 10th -11th
Details to follow.
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 05/05/23.
Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them on The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:
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[email protected]
Alan,
I recently registered for Thursday’s webinar and looking forward to it.
I have a question for now if okay.
I was watching one of your videos on the premium site about ultra low risk strategies involving delta and implied volatility. Do you have a preference of one over the other and if so why?
Thanks a lot.
Bert
Bert,
Using IV to establish a projected trading range for a specific option contract expiration cycle will have approximately an 84% accuracy.
One of the definitions of Delta, is the approximate probability of the strike expiring in-the-money or with intrinsic-value.
Both offer reliable (but not precise) guidelines for probability of success trades. Generally, the high and low end strikes established using both will be similar but not always exactly the same. I am comfortable using either one or both to confirm.
See you Thursday.
Alan
Alan,
You’ve probably been asked this a dozen times, but for the purpose of CSPs and CC writing, which would you suggest is the better choice….GOOG or GOOGL?
Thanks,
Joanna
Joanna,
Both are outstanding companies that will generate 1 1/2% – 3% initial time-value monthly returns for near-the-money strikes.
Neither are currently on our “eligible” watch lists because they fall slightly short of being “elite-performers” from earnings-per-share perspectives, but both are darn close.
They are so close in every category that we can literally flip a coin if we wanted to choose between the two.
Alan
Hello again Alan.
On 4/18 I bought 900 shares SKY @73. I STO at that time 9 lots exp 5/19 strike 70 for 5.20.
Stock has been rising but today dropped 5.25%. Still at 70.97 in the money.
I checked your most recent stock list and found SKY now off the running list.
If I hold until expiration I will profit about $2000. But I am leaning to btc tomorrow and sell stock. My profit would be only $630 but this may be safer.
If stock wasn’t off your list I wouldn’t do it. What do you think?
Barry R
Barry,
I cannot give specific financial advice in this venue, but I can make general comments you should find helpful.
Once we have made selections from our premium watch lists, we manage those trades using our exit strategy arsenal described in our books and videos, not by their removal from our watch lists.
This includes having our 20%/10% BTC GTC limit orders in place with an eye on our 7% price guideline for the stock.
The reason we update the stock and ETF reports weekly for our members is in case we need a replacement security; we select from the most recent watch lists.
SKY is a volatile security, triple the implied volatility of the S&P 500, so we should expect price gyrations during the contract cycle.
Alan
Another question Alan.
If I sell covered calls with only 2 weeks to expiration is there enough time to implement the btc 10/20% strategies.
Thanks as always.
Barry
Barry,
Yes. With 2 weeks remaining until contract expiration, we change the 20% BTC GTC limit orders to 10%.
Alan
Premium members:
This week’s 4-page report of top-performing ETFs has been uploaded to your premium site. The Select Sector SPDR section is now crafted to align with our streamlined (CEO) approach to covered call writing. The report also lists Top-performing ETFs with Weekly options, mid-week market tone as well as the implied volatility of all eligible candidates.
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Alan and the BCI team
Hi Alan,
I have a quick question on how I should handle this situation. I have gotten through a lot of the materials and am finally using the Trade Management System starting with the May 26th contracts
I have ABBV currently as a long-term position I sold a covered call on it and then closed out the initial call and rolled down in the same contract cycle. I ended up buying back the second call but I do not see a place to enter in the BTC on the second option. I was thinking of simple deducting that from the initial premium on the second option to give me an accurate number.
Is this the way to handle it?
Thank you again.
Robert
Robert,
Glad to help.
The TMC does account for multiple exit strategies in the same contract cycle. It involves closing the 1st exit strategy and starting a new line in the spreadsheet for the 2nd exit strategy. We must also utilize the capital adjustment section so that the total investment stat is accurate. See Chapter 14 of my book, Exit Strategies for Covered Call Writing, pages 71-79 for a real-life example and get back to me if you require additional clarification.
Alan
Thanks Alan I will take a look at it again and I think i should be able to figure it out. I am eager to see after a few months using the TMC what my tendencies are and adjust accordingly if I have to.