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Avoiding Earnings Reports: Two Common Sense Perspectives

Never sell a covered call option or a cash-secured put for a stock with an upcoming earnings report. This is one of the most important rules in the BCI methodology. As a matter of fact, most other principles I refer to as guidelines because there is some leeway or flexibility to them. For example, the 20%/10% guidelines allow us to veer slightly from those specific numbers.

 

First perspective: Gap-downs

The most obvious reason for avoiding these quarterly publications is that a disappointing report can result in a dramatic decline or gap-down in share value wiping out the option credit and potentially much more. We must avoid this risk. The good news is that we know the date of the report and so we can maneuver around them in various ways and thus totally eliminate earnings report risk…problem solved. Earnings dates are highlighted in our Premium Member Stock Reports as shown in the screenshot below:

covered call writing and earnings reports

Premium Stock Report: Earnings Dates

The red arrow points to the column with earnings dates and the gold rows highlight those stocks that report in the current contract month.

 

A second perspective- Gap-ups

Just as reports can disappoint resulting in a gap-down, they can positively surprise culminating in a gap-up. On 8/11/2016, Acacia Communications Inc. (ACIA) reported earnings after the bell and the after-market price took off like a rocket ship from $70.00 per share to nearly $94.00 per share where it closed the next day. The chart below reflects the gap-up in the yellow field:

earnings reports and option-selling

Gap-up of ACIA after a Positive Earnings Surprise

Most of the time we will not own shares until after earnings reports pass. There are times, however, when we have a lot of confidence in a stock and decide to keep it despite the report. As an example, MKSI had 16 consecutive quarters of “earnings beats” as of February, 2017. I used to own shares through earnings releases with CSCO and AAPL years ago when those companies always muted guidance resulting in positive earnings surprises. If we do take this approach, it still is in our best interest to avoid selling the options until the reports pass. In the case of ACIA, we could have benefitted by the $24.00 gap-up and then written the call after the report passed and price settled down.

 

Discussion

Avoiding earnings reports when selling call or put options is a critical rule from two perspectives. By not owning the stock, we circumvent the risk of a gap-down resulting from a negative surprise. Secondly, if we do decide to own the shares through the report, we can benefit from a gap-up in price caused by a positive surprise.

***My thanks to Joan K. for inspiring this article.

 

Upcoming live events

1- February 27 and 28th, 2017

Stock Trader’s Expo

Marriott Marquis Hotel, NYC

1:30 PM ET (Monday)

1:30 ET (Tuesday)- This presentation will be webcast by The Money Show

Exhibit Hall Booth 208 (February 26th – 28th) … come say hi to the BCI team

2- March 21st and 22nd, 2017

Two live Florida events (Fort Lauderdale -22nd and Delray Beach- 21st)

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3- April 12, 2017

Income Generation Webinar for The Options Industry Council

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4- RECENTLY ADDED

AAII National Investor Conference

American Association of Individual Investors

November 3rd – November 5th, 2017

Loews Royal Pacific Resort
Orlando, Florida
Details to follow

Market tone   

Global stocks continued gains this week as reflationary hopes were rekindled by President Trump’s discussion of US tax cuts. Oil prices were steady with West Texas Intermediate crude holding at $54.10 per barrel. Volatility, as measured by the Chicago Board Options Exchange Volatility Index (VIX) fell to 10.85 from 11.15 last week. This week’s reports and international news of importance:

  • Greece faces a deadline to receive much-needed bailout funds from its international backers, but so far it has not fulfilled the terms of its prior commitments. Greece hopes to strike a deal at the last EU summit before the European election calendar kicks off in March. The IMF called Greece’s debt burden unsustainable and called for debt forgiveness
  • Populist French presidential candidate Marine Le Pen formally kicked off her campaign this week, laying out her economic agenda. Le Pen called for pulling France out of the eurozone, reintroducing the franc and drastically curbing immigration
  • Having peaked in 2015 at over $4 trillion, China’s foreign exchange reserves slipped below $3 trillion in January. Beijing has been selling down reserve assets for the past 18 months to try to stem capital outflows from the Chinese mainland
  • The UK House of Commons voted on Wednesday to allow the government to begin negotiations with the European Union
  • A US federal judge upheld the legality of the US Department of Labor’s fiduciary rule on Wednesday. The rule, scheduled to go into effect on 10 April, would require financial advisors to act in their clients’ best interest when advising them about retirement accounts. Critics say the rule will limit consumer choice and make giving advice too costly
  • German finance minister Wolfgang Schaüble acknowledged that the euro’s exchange rate with the US dollar is too low for Germany’s competitive condition but said that the European Central Bank must make policy for all of Europe, not just Germany. Tensions were inflamed both inside and outside the eurozone as Germany posted a record annual trade surplus. Donald Trump’s principal trade advisor commented recently that Germany has been manipulating the euro exchange rate in order to gain competitive advantage.
  • US president Donald Trump spoke by phone for the first time with Chinese president Xi Jinping and reaffirmed the US commitment to the One China policy President Trump also met with Japanese prime minister Shinzo Abe at the White House later on Friday
  • As of 7 February, Thomson Reuters reports that fourth-quarter earnings for the S&P 500 Index are expected to increase 8.2% from the fourth quarter of 2015. Of the 300 companies in the S&P 500 that have reported to date for the fourth quarter of 2016, 68% have reported earnings above analyst expectations
  • The Q4 2016 blended revenue growth estimate is 4.3%
  • The forward four-quarter (1Q17– 4Q17) P/E ratio for the S&P 500 is 17.4

 

THE WEEK AHEAD

MONDAY, February 13th

  • None scheduled

TUESDAY, February 14th

  • Producer price index
  • Janet Yellen testimony

WEDNESDAY, FEB. 15th

  • Consumer price index
  • Core CPI
  • Retail sales
  • Industrial production
  • Home builders’ index

THURSDAY, FEB. 16th

  • Weekly jobless claims
  • Housing starts
  • Building permits

FRIDAY, FEB. 17th

  • Leading economic indicators

For the week, the S&P 500 was up by 0.81% for a year-to-date return of 3.45%. 

Summary 

IBD: Market in confirmed uptrend

GMI: 5/6- Buy signal since market close of November 10, 2016

BCI: I am currently fully invested and have an equal number of in-the-money and out-of-the-money strikes.  I was encouraged with the positive earnings surprises that have dominated this earnings season.

WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US

The 6-month charts point to a neutral to slightly bullish outlook. In the past six months, the S&P 500 was up 6% while the VIX (10.85) declined by 10%.

_____________________________________________________

Wishing you the best in investing,

Alan (alan@thebluecollarinvestor.com) and the BCI team

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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.

25 Responses to “Avoiding Earnings Reports: Two Common Sense Perspectives”

  1. Barry B February 11, 2017 10:59 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 02/10/17.

    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 BCI Team

    • Jay February 12, 2017 10:54 pm #

      Hey Barry,

      I see our stock list is sneaking up in size spilling over to a second page! The list usually grows after earnings season if the Technicals are reasonable.

      I’m not surprised we still like Anything@Bank,com and Anything@Chip.com :)!

      I love having shopping money the week before monthly expiry. If we get down days I am going to be a salmon in a different stream buying THO and UTHR on weakness.

      Oh, but silly me, I forget this is the Trump Rally: things only go up :)! A great week to all….- Jay

      • Roni February 13, 2017 4:12 pm #

        Hi Jay,

        I agree. Shopping money one week before expiry Friday is great.

        I’m not sure I can wish you a down day. ??? Down days may lead to downturn or worse.
        Although I believe there are no major events ahead indicating a reversal of this bullish trend, down days will always be part of the game.

        I am saving my cash for next week, cause it makes no difference to me, as I only do buy/writes with covered calls.

        Take care – Roni

        • Jay February 13, 2017 11:13 pm #

          Hey Roni,

          Thanks for your note. I hope your encouragement below to our potential friend works out because she sounds like a smart market voice!

          I did not do anything today. I am always wary on days when SPY and VIX both go up.

          Aretha sang “Who’s Zoomin’ Who?”

          https://www.youtube.com/watch?v=f2NXv9RL1i8

          They can not both be right. Most of the time VIX wins that one. So a good day to sell covered calls. And better days to sell cash secured puts seem just around the corner! – Jay

          • Roni February 14, 2017 8:16 am
            #

            Got it Jay,

            Thanks for Aretha song, I am a huge fan.
            I will watch it tomorrow night when I get home, Today I’m at the office (I work 2 days a week).

            Roni

  2. Steve February 13, 2017 2:33 am #

    Alan,

    I am enjoying your materials and appreciate how you present the information in a way that is easily understood. I have been trying to learn how to incorporate options into my trading for years, but never really figured out how to do so. You present a very rational, complete approach that is simple but powerful.

    I have another Dentist friend who has been successfully using covered calls for years who seems to do almost everything opposite of you (he trades expensive tech stocks without diversification, trades through earnings reports, never looks at technicals, trades weekly options, etc.) who seems to earn similar returns as you. In fact, his wife sells at-the-money covered calls on her elderly aunt and uncle’s $280 K retirement account and has consistently produced an $8K monthly cash flow for them during the last several years.

    Although I prefer your approach, my friend showed me how the weekly option premiums over a 1 month period add up to a higher return than the monthly option premiums. It also seems like trading weekly options would minimize the need for your exit strategies. Are there any downsides to trading weekly options that cause you to prefer monthly over weekly covered calls?

    Thanks,

    Steve

    • Alan Ellman February 13, 2017 7:54 am #

      Steve,

      There are pros and cons to Weeklys as there are to all strategies and approaches. I prefer Monthlys but respect those who use Weeklys which, in my view, can also be a great source of cash flow.

      WEEKLYS: PROS AND CONS TO CONSIDER

      Positives:

      • Annualized returns can be higher
      • Can avoid exposure over weekends
      • Can generate greater premium as earnings report dates are approached and trade up to the week before earnings

      Negatives:

      • The pool of stocks with Weeklys is much smaller than those with Monthlys potentially resulting in lower-quality underlyings
      • Management is much more time-consuming as “rolling” possibilities come up every week
      • Less time for exit strategy execution
      • Quadruple the number and amount of commissions
      • Lower option liquidity
      • Wider bid-ask spreads

      Alan

      • MarioG February 14, 2017 1:09 am #

        Other possible negatives with weeklies, in my opinion:

        More documentation time needed to keep track of your trades in a portfolio.

        Forces you to stay glued to your computer chair compared to monthly covered calls.

        May affect your family life adversely.

        So it is a matter of weighing the positives and negatives to your personal situation.

        Mario G.

    • Roni February 13, 2017 9:37 am #

      Hello Steve,

      Your friend’s wife must be very smart and competent.
      I would love to exchange ideas with her.
      Maybe you can ask her to join this blog ?

      Thanks – Roni

  3. Adrian February 13, 2017 4:21 am #

    Hi Alan, It has been quite some time since I last gained some knowledge from you, so hoping I can again grow a little wiser this year from whatever advise you can send me.

    Here is below my buildup of 5 questions mainly about the Technicals:-
    1. If the Market is very positive/bullish you told me that if the stock has mixed technical indicators then you would still sell OTM strikes.
    But would you still if there is a divergence, or divergences on the stock?

    2. If I have an 20% option buyback at the 0.26c mark(from the original $1.30), but the options chain for the ‘ask-price’ is only in 0.05c increments, then does this mean my order won’t get filled until the options price is lower at 0.25c, or 0.20c?

    3. If I have all high-beta stocks and price corrects you’ve said we can then change the ITM/OTM strike price ratios.
    Now I don’t split up my ratios per stock as this seems more time-consuming, so can you tell me how I would actually go about doing that?(could I in this case maybe use a different buyback % parameter?)

    4. If the stock is above both EMA’s and the MACD is positive, but Slow-Stochastics has just gone S/ways for 1 day, then here would you be viewing the stock technicals as mixed?

    5. In your book you have emphasised volume as a key technical indicator, although I don’t look at it as much as the others there is one situation I would like to better understand.
    It happens when there is a big sell volume spike,- how soon prior to when you want to buy would this come as a warning(not to buy),- like perhaps no more than 1 week prior, etc? (the opposite holds true for any buy volume spikes?)

    That’s all I have for now. I was considering at first whether to later this year trade for real. Now have thought about to papertrade through another market correction or two first to be of more benefit, the factor is just how long until they come around. Hopefully not to long, but only time will tell.
    Thanks for your help.

    • Alan Ellman February 14, 2017 2:54 pm #

      Adrian,

      1- Unexpected extreme news aside, the movement of the overall market has the greatest impact on share price in the short-term. With “mixed technicals” on stocks that are also elite performers fundamentally in a bull market guides me to OTM strikes. Now, if we held multiple contracts we can “ladder” this to mostly OTM and with a small percentage of ITM. If an investor has a particularly low risk tolerance then ITM strikes may be appropriate 100% of the time.

      2- Whenever we submit option orders, there are certain minimum amounts that a price can change. These minimum amounts are called the “tick size”. Currently, option orders priced below $3 can be submitted in five-cent increments and option orders above $3 must be submitted in ten-cent increments.

      This means that there is a five-cent tick size for option orders at $3.00 and below and a ten-cent tick size for all option orders above $3.00. If we try to submit an order above $3 in five-cent increments, such as $3.15, it would be rejected and returned to us.

      There is now a growing list of options trading in pennies where any amount can be entered so these tick size rules are likely to be changed in the near future.

      The 20%/10% guidelines are just that…guidelines. So our options should be bought back at “approximately those percentiles.

      3- I will stand by the 20/10% guidelines in all circumstances and historical volatilities. If your preference is not to “ladder” strikes (my preference in markets not totally defined) and the market assessment is bearish/volatile, then I would use all ITM strikes and take a defensive posture.

      I’ll come back to 4 and 5.

      Alan

      • Alan Ellman February 17, 2017 2:13 pm #

        Adrian,

        4- With all technical indicators bullish except 1-day of sideways slow stochastics, I would still view this as a bullish technical chart. Keep in mind that technical analysis is open to interpretation but this would definitely be my take.

        5- I use volume in 2 regards:

        – A volume spike will confirm changes in other chart technical. For example, if the stochastic oscillator dips below the 80% on very light volume, it is less of a red flag than had it occurred on a volume surge.

        – A volume surge will confirm EMA trends or serve as negative volume divergence if moving against the uptrend.

        Technical analysis is an important factor to analyze but not the only one.

        Alan

  4. Nathan February 13, 2017 4:58 pm #

    Alan,

    I have a fairly large retirement account with several holdings. I wanted to derive monthly income from them without having a need to liquidate since I want to hold them.

    I am not trading as a business. Can you advise?

    Thanks,
    Nathan

    • Jay February 14, 2017 1:22 pm #

      Nathan,

      I am certain Alan’s reply will be both informative and profitable!

      The only reason I am sticking my nose in offering a few thoughts is because our situations sound similar. I am retired on a nest egg. I pay my bills with options and dividend income

      A thought process I find useful is ask “How much option cash flow do I want from my portfolio this month?”

      Be careful to never confuse cash flow with income. The concept of income has a finality to it that often frustrates new covered call writers. You only “keep” your options premiums from a portfolio perspective if your stock stays the same or goes up. If it goes down it is no longer income, it is loss protection which is not a bad thing either and helps your portfolio!

      I’ve had investing pals lecture me over a friendly beer that covered call writing is counter productive because you lose your winners and keep your losers. Well, maybe, if you do it exclusively and never heard of exit strategies :)!

      I split holdings between growth and income. Sometimes the same security serves both. I have QQQ shares and LEAPS. I cover some for cash flow and let the rest run each month.

      Please take the time to educate yourself first with the complimentary material on this site and certainly buy Alan’s Complete Encyclopedia. He pays me no honorarium for saying that but he should :).

      I wish you great success! – Jay

    • Alan Ellman February 14, 2017 3:52 pm #

      Nathan,

      The strategy you should explore based on your stated parameters is “portfolio overwriting” Here is a link to one of the resources Jay referenced:

      https://www.thebluecollarinvestor.com/portfolio-overwriting-should-we-sell-1-month-or-2-month-expirations/

      (notice I’m ignoring his “should get paid” comment)

      Both versions of the “Complete Encyclopedias” have chapters dedicated to this topic.

      Alan

  5. MarioG February 14, 2017 12:54 am #

    Alan,

    Just want to reinforce your Blog Article for this month on avoiding Earning Reports. On a 200,000 portfolio with 4% cash reserve ($8,000) leaves 192,000 for trading.

    Not being greedy, if you can earn 2% per month average (money doubles every 3 years at 24% per year), the 2% is a gain of $3840 per month.

    Divided into 6 securities that $32,000 per position. A 10% drop from earnings is $3200. That’s significant compared to your monthly earning. That your hard earned money.

    In addition other scenarios can occur throughout the year; Securities going south, emotions getting involved, not unwinding when recommended, accidental trading though an earning report, a bad overall month, not staying 92% invested, under-performing below 2% per month, restoring at times to 1-2% ETF’s, taking time off for some other activities, or just making some errors. So it is important to minimize the possibility of a loss.

    Following your methodology adds a buffer to your positions so even if things don’t go perfectly you can end up at the end of the year with 16-18% and still be happy.

    Regards,

    Mario G.

    • Alan Ellman February 14, 2017 3:00 pm #

      Mario,

      Well-stated. Avoiding earnings reports is one of the 3 prongs of security selection (common sense principles). Option selection and position management are the other 2 required skills.

      Alan

  6. Tremaine February 15, 2017 11:06 am #

    Alan,

    What is the minimum amount of money I should have available to open an account? Thank you for all of your assistance in this matter.

    Sincerely,
    Tremaine

    • Alan Ellman February 15, 2017 1:23 pm #

      Tremaine,

      Many brokerages require a minimum amount of cash to open a brokerage account of at least $1000.00. To use the option-selling strategies you are currently studying, a guideline of $10 – $15k for ETFs and $25 – $35k for individual stocks would represent minimum requirements.

      Studying and paper-trading the strategies can start immediately no matter how much cash is available.

      Alan

    • Jay February 15, 2017 7:36 pm #

      Tremaine,

      Welcome to our group! As Alan advised there is no substitute for studying these strategies and paper trading before you invest a dime!

      There is also a largely overlooked component which is assessing to what degree your temperament as an investor is suited to covered call writing or cash secured put selling.

      These are conservative strategies designed to hit single after single to score runs one month at a time. Everyone says “sign me up for that” until they buy a NVDA, make a 4% covered call trade for the month only to see it zoom up 10% and feel left at the bus stop unless they spend a lot of money to buy back the call with no guarantee it won’t retrace making them feel worse!

      When I first started selling options I covered everything I owned. I thought, “Man look at this income, it’s great!” It did not take long to realize winners with truncated upside do not pay for losers with unlimited downside.

      So I studied exit strategies and variation between ITM, ATM and OTM strikes and my results improved. Fancy that, I did my homework and started to do better at school :).

      I also learned I have a strain of River Boat gambler in me. It drove me bat sh– when a growth stock I covered even OTM went to the moon past my strike. I don’t cover many of those anymore. I strike a balance that works for me per my comments above.

      The point of this post is the steps in the game are: study. practice and understand your investing temperament. If that helps in any way :)? . – Jay

  7. Jim February 15, 2017 1:28 pm #

    Alan;

    You’ve said you would usually make a covered call buy for the 3/17 expiration date on Monday 2/21 or Tuesday 2/22.

    My next CC will be on SSTK with a 3/17 date.
    An OTM CC with a strike of $57.50 today is $1.60…

    By waiting til next week, are the odds with me that I can still get a $1.60 bid price, or should I place the CC now to lock in the bid price?

    As I have not yet experienced the “when to buy” strategies, I’d rather not leave money on the table and have to take a lower premium.

    Thanks

    Jim

    • Alan Ellman February 16, 2017 1:53 pm #

      Jim,

      The best investors develop a strategy that have rules and guidelines and stick with them. Like taking a card in blackjack when we hold a “16” and the dealer holds an Ace…slightly to our benefit to take a card. When selling covered calls we want to take advantage of any and every edge we can. In my view, it is best to wait until Monday or Tuesday of the new contract month…we will win more often than lose by taking this approach. The reasons include:

      1- Logarithmic nature of time value erosion…we lose very little by waiting.

      2- Avoiding 1 weekend of market risk.

      3- Market makers deduct weekend time value on Thursday or Friday prior to the weekend so we may end with additional risk and no additional premium.

      This is not a major edge but an edge nonetheless in my humble opinion.

      Alan

      • MarioG February 18, 2017 5:06 am #

        Alan,

        I want to exploit your comments further on investing guidelines throughout the cycle and in particular for Weeks 3 and 4 when you still have some small percentage cash available for trading. This is a common situation.

        Weeks 1-2 of 4 week cycle:
        I am trying to stay at least 92% invested with the 4 accounts, 2 are Retirements accounts divided between Fidelity and Optionshouse. I normally trade the same security in multiple accounts, laddering when possible ITM / OTM. I check the BCI Run list and top ETFS, recheck the ER date, Open Interest and Spread thresholds, then calculate, on paper, ROO% for ITM and OTM cases. I do calculate CSPuts ROO% at times to diversify my trading or add a trading possibility. I have experienced some CSPut assignments to get a total experience with a discounted security.

        When looking at the Run list I first look at securities with Positive technicals (later check the mixed). I check the charts to see if there are High volatility swings, which I try to stay away from in the history. I calculate the BEP to see how the chart has traded above that threshold, since I will increase the likelihood it will have a positive gain. If the ITM calculates to at greater than 2% that is something I will consider for a trade, particularly if the chart shows sideways movement. If an upward trend movement exist in the chart or it looks likely, I consider the OTM trade as well.

        Weeks 3 of 4 of week cycle:
        Based on your comments. you do not feel it is overall rewarding to look at the next contract cycle at Weeks 34. Can we say if one has some cash available, that in Week 3, look at the current cycle and accepts a lower ROO% 1% or less (including taking into account commissions). With 10,000 or extra cash, that is under $100 or less Gain. Every dollar counts, though sometimes the time and work effort this entails may not seem worthwhile. I know you have stated small profits can total up to a significant amount it this normally occurs on a regular basis. You can then run your Exit Strategy at Expiration Friday for the next cycle.

        Week 4:
        In Week 4, your view is to keep the cash and do not consider a trade until Week 1 of the next cycle. Not worth the additional risk.

        Note: I remember from either one of your books or other presentations that you gave an example of a CC that crossed from Week 3 or 4 into the next contract cycle. But I understand the Risk precautions you have explained where to do that is not a normal recommended step.

        Regards,

        Mario

        .

        • Alan Ellman February 19, 2017 6:20 am #

          Mario,

          Your approach to our BCI methodology is sound and reasonable.

          When I close a position in week 3 and a 4-week contract or week 4 of a 5-week contract, I like to generate at least 1% of time value. We must be sure to leave some cash available in case we need to execute a last-minute exit strategy. These guidelines are based on the logarithmic nature of time value erosion (very little time value left as Monthly contracts are nearing expiration) and the inherent risk of entering our positions and not having a lot of time to mitigate trades that turn against us.

          Your approach is very well stated.

          Alan

  8. Alan Ellman February 15, 2017 5:59 pm #

    Premium members:

    This week’s 8-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site. The report also lists Top-performing ETFs with Weekly options as well as the implied volatility of all eligible candidates. For your convenience, here is the link to login to the premium site:

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

    NOT A PREMIUM MEMBER? Check out this link:

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

    Alan and the BCI team

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